Initial investment npv irr project 1 822800 0 1200

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and internal rate of return (IRR) analyses of the two projects being discussed are as follows. Initial Investment NPV IRR Project 1 $822,800 $0 12.00% Project 2 $300,000 $49,469 17.65% Project 1 is expected to have a positive after-tax cash flow of $200,000 per year for six years after the initial investment, and Project 2 is expected to have a positive after-tax cash flow of $85,000 for six years after the initial investment. During the meeting, Conrad was asked to explain several issues related to his analysis of the projects. REQUIRED: 1. Because of volatility in the financial markets, the company’s cost of equity may be higher than assumed in this analysis. This is important as RomCo is entirely equity financed. a. What cost of equity was used in this analysis? Explain your answer. b. Would an increase in the cost of equity affect the NPV and IRR of the projects, and thus the desirability of undertaking the projects? Explain your answer. 2. There is a possibility that the corporate income tax rate may be lowered in the near future. If this were to occur, how would this affect the NPV and IRR of the projects, and the desirability of investing in the projects? 3. a. What is the payback period for each project? Show your calculations. b. Identify and explain three weaknesses of using the payback period to decide on doing these projects.
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366 Question 2.22 – Kolobok Kolobok, Inc. produces premium ice cream in a variety of flavors. Over the past several years, the company has experienced rapid and continuous growth and is planning to increase manufacturing capacity by opening production facilities in new geographic areas. These initiatives have put pressure on management to better understand both their potential markets and associated costs. Kolobok’s management identified three aspects of their current operation that could affect the new market expansion decision: (1) a highly competitive ice cream market, (2) the company’s current marketing strategy, and (3) the company’s current cost structure. Since the company began operations in 1990, Kolobok has used the mark-up approach for establishing prices for six-gallon containers of ice cream. The product prices include the cost of materials and labor, a markup for profit and overhead cost (a standard $20), and a market adjustment. The market adjustment is used to appropriately position a variety of products in the market. The goal is to price the products in the middle of comparable ice creams offered by competitors while maintaining high quality and high differentiation. Sales for 2007 based on Kolobok’s mark-up pricing are presented below by product. Product Material & Labor Markup Market adjustment Unit Price Boxes sold Total Materials & Labor Total Sales Vanilla $29.00 $20.00 $1.00 $50.00 10,200 $295,800 $510,000 Chocolate 28.00 20.00 7.00 55.00 12,500 350,000 687,500 Caramel 26.00 20.00 2.00 48.00 12,900 335,400 619,200 Raspberry 27.00 20.00 2.00 49.00 13,600 367,200 666,400 Total 49,200 $1,348,400 $2,483,100 For the year 2007, Kolobok’s before-tax return on sales was 7%. The company’s overhead expenses were $500,000, selling expenses $250,000, administrative expenses $180,000, and interest expenses were $30,000. Kolobok’s marginal tax rate is 30%.
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