9.There are two particularly important considerations. The first is erosion. Will the “essentialized”book simply displace copies of the existing book that would have otherwise been sold? This is ofspecial concern given the lower price. The second consideration is competition. Will other publishersstep in and produce such a product? If so, then any erosion is much less relevant. A particularconcern to book publishers (and producers of a variety of other product types) is that the publisheronly makes money from the sale of new books. Thus, it is important to examine whether the newbook would displace sales of used books (good from the publisher’s perspective) or new books (notgood). The concern arises any time there is an active market for used product.

Chapter 8: Making Capital Budgeting Decisions Page 2

10.Definitely. The damage to Porsche’s reputation is a factor the company needed to consider. If thereputation was damaged, the company would have lost sales of its existing car lines. 11.One company may be able to produce at lower incremental cost or market better. Also, of course,one of the two may have made a mistake!12.Porsche would recognize that the outsized profits would dwindle as more products come to marketand competition becomes more intense.Solutions to Questions and ProblemsNOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiplesteps. Due to space and readability constraints, when these intermediate steps are included in thissolutions manual, rounding may appear to have occurred. However, the final answer for each problem isfound without rounding during any step in the problem.Basic1.Using the tax shield approach to calculating OCF, we get:OCF = (Sales – Costs)(1 – tC) + tCDepreciation OCF = [($7 × 2,500) – ($2 × 2,500)](1 – 0.34) + 0.34($39,000/6) OCF = $10,460So, the NPV of the project is:NPV = –$39,000 + $10,460(PVIFA14%,6)NPV = $1,675.46Since the NPV is positive, the company should accept the project.2.We will use the bottom-up approach to calculate the operating cash flow for each year. We also mustbe sure to include the net working capital cash flows each year. So, the total cash flow each year willbe:Year 1Year 2Year 3Year 4Sales$11,500$12,800$13,700$10,300Costs2,0002,0002,0002,000Depreciation6,0006,0006,0006,000EBT$3,500$4,800$5,700$2,300Tax1,1901,6321,938782Net income$2,310$3,168$3,762$1,518OCF$8,310$9,168$9,762$7,518Capital spending–$24,0000000NWC–300–350–300–2501,200Incremental cash flow–$24,300$7,960$8,868$9,512$8,718Chapter 8: Making Capital Budgeting Decisions Page 3

CHAPTER 8 B-4The NPV for the project is:NPV = –$24,300 + $7,960 / 1.12 + $8,868 / 1.122+ $9,512 / 1.123+ $8,718 / 1.124NPV = $2,187.563. Using the tax shield approach to calculating OCF, we get:OCF = (Sales – Costs)(1 – tC) + tCDepreciation OCF = ($2,300,000 – 1,075,000)(1 – 0.35) + 0.35($2,800,000/3) OCF = $1,122,916.67So, the NPV of the project is:NPV = –$2,800,000 + $1,122,916.67(PVIFA10%,3)NPV = –$7,472.454.The cash outflow at the beginning of the project will increase because of the spending on NWC. Atthe end of the project, the company will recover the NWC, so it will be a cash inflow. The sale of theequipment will result in a cash inflow, but we also must account for the taxes which will be paid onthis sale. So, the cash flows for each year of the project will be:YearCash Flow0–$3,100,000