c n 7 T 38 r 15 d 30 Expected Aftertax Present Value Year Event Cash Flow Cash

C n 7 t 38 r 15 d 30 expected aftertax present value

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c. n = 7 T = 38% r = 15% d = 30% Expected Aftertax Present Value Year Event Cash Flow Cash Flow @ 15% 0 The M. Sun $(320,000) $(320,000) 0 W. C. @15% (48,000) (48,000) 1-3 Revenues 90,000 55,800 127,404 4-7 Revenues 115,000 71,300 133,844 7 Salvage 25,000 9,398 7 WC recovery 48,000 18,045   554 , 73 9347826 . 2533 . 602 , 310 15 . 1 15 . 5 . 1 30 . 15 . 38 . 30 . 398 , 9 000 , 320 NPV = $(5,755) Do not take on the Midnight Sun. Foundations of Fin. Mgt. 10Ce Block, Hirt, Danielsen, Short, Perretta
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13 - 38 Chapter 13 d. If instead of a firm beta we have an equity beta we will have to calculate the cost of capital based on a weighting of debt and equity. The cost of equity capital: CAPM K j = R f + j ( R m R f ) = 0.03 + 2.0 (0.08) = 0.190 = 19% Overall cost of capital = .44 0.0953 (1 .38) + 56% 0.19 = .44 0.059086 + 0.1064 = 0.026 +0.1064 = 0.1324 = 13.24% n = 7 T = 38% r = 13.24% d = 30% Expected Aftertax Present Value Year Event Cash Flow Cash Flow @ 13.24% 0 The M. Sun $(320,000) $(320,000) 0 W. C. @15% (48,000) (48,000) 1-3 Revenues 90,000 55,800 131,217 4-7 Revenues 115,000 71,300 145,324 7 Salvage 25,000 10,470 7 WC recovery 48,000 20,102   835 , 76 94154 . 263645 . 530 , 309 1324 . 1 1324 . 5 . 1 30 . 1324 . 38 . 30 . 470 , 10 000 , 320 NPV = $15,948 The Midnight Sun should be accepted. Foundations of Fin. Mgt. 10Ce Block, Hirt, Danielsen, Short, Perretta
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13 - 38 Chapter 13 MINI CASES Churchill's Muffins (Investment Decision with NPV and Risk Analysis) Standard (company-owned) P × NPV (in $ thousands) .30 × 1,450 = 435 .40 × 630 = 252 .30 × (200) = (60) D = 627 D D (D– D ) (D– D ) 2 P (D– D ) 2 P 1,450 627 823 677,329 .30 203,199 630 627 3 9 .40 4 – 200 627 – 827 683,929 .30 205,179 408,382 639 382 , 408 02 . 1 627 639 D V variation of t Coefficien Expanded (company-owned) P × NPV (in $ thousands) .30 × 3,812 = 1,144 .40 × 740 = 296 .30 × (900) = (270) D = 1,170 D D (D– D ) (D– D ) 2 P (D– D ) 2 P 3,812 1,170 2,642 6,980,164 .3 2,094,049 740 1,170 430 184,900 .4 73,960 Foundations of Fin. Mgt. 10Ce Block, Hirt, Danielsen, Short, Perretta
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13 - 38 Chapter 13 – 900 1,170 – 2,070 4,284,900 .3 1,285,470 3,453,479 858 , 1 479 , 453 , 3 59 . 1 170 , 1 858 , 1 D V variation of t Coefficien The numeric analysis indicates that, on an expected values NPV basis, the expanded size alternative is far superior. The risk measure, on the other hand, certainly favors the standard size alternative. Note that the return advantage of the expanded alternative rests entirely with the enormous potential under the "very favorable" outcome. The downside risk is also very high under this alternative. The franchisee alternative offers lower potential returns but very little risk since the investment by the firm in case of poor franchisee performance will come mostly in the way of additional managerial troubleshooting efforts and the necessity to forgo royalties in order to ensure the survival of a franchisee under adverse conditions. In real life, Churchill's (disguised name) actually elected for the standard, franchised alternative. Under this one the franchisee still stood to make a reasonable return with lower risk to himself and also to the company (less investment for the company plus better experience historically under the franchisee option). Importantly, this allowed John's dad to begin withdrawing funds from the firm
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