Finally, 21st Century is also considering Project Z Project Z has an up-front after-tax cost of...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Finally, 21st Century is also considering Project Z Project Z has an up-front after-tax cost of $500,000, and it is expected to produce after-tax cash flows of $100,000 at the end of each of the next 5 years (t=1, 2, 3, 4, and 5). Because Project Z has a WACC of 12%, it clearly has a negative NPV. However, Keller and his group recognize that if 21st Century goes ahead with Project Z today, there is a 10% chance that this will lead to subsequent opportunities that have an expected net present value at t=5 equal to $3,000,000. At the same time, there is a 90% chance that the subsequent Bopportunities will have an expected negative net present value (-$1,000,000) at t=5. On the basis of their knowledge of real options, Keller and his group understand that the company will choose to 5 develop these subsequent opportunities only if they appear to be profitable at t=5. Given this 6 Information, should 21st Century invest in Project Z today? Explain your answer. 7 8 WACC= 12% 9 Scenario NPV 0 End of time period @t=0 1 1 2 3 2 10% ($500,000) $100,000 $100,000 $100,000 4 $100,000 5 43 $100,000 $3,000,000 $1,562,758.19 44 45 90% ($500,000) $100,000 $100,000 $100,000 $100,000 46 $100,000 ($1,000,000) Will not do -$139,522.38 47 48 Project NPV 49 50 If it turns out that the project at Year 5 has a negative NPV of future opportunities, the firm will not 51 pursue them. Therefore, the cash flows for that branch of the decision tree include only the 52 $500,000 outlay and the $100,000 inflows. Therefore, the expected NPV of Project Z is 153 (0.10)($1,562,758.19)+(0.9)(-$139,522.38) = $30,705.68. Therefore, Project Z has a positive NPV so 154 the firm should invest in it today. 155 Finally, 21st Century is also considering Project Z Project Z has an up-front after-tax cost of $500,000, and it is expected to produce after-tax cash flows of $100,000 at the end of each of the next 5 years (t=1, 2, 3, 4, and 5). Because Project Z has a WACC of 12%, it clearly has a negative NPV. However, Keller and his group recognize that if 21st Century goes ahead with Project Z today, there is a 10% chance that this will lead to subsequent opportunities that have an expected net present value at t=5 equal to $3,000,000. At the same time, there is a 90% chance that the subsequent Bopportunities will have an expected negative net present value (-$1,000,000) at t=5. On the basis of their knowledge of real options, Keller and his group understand that the company will choose to 5 develop these subsequent opportunities only if they appear to be profitable at t=5. Given this 6 Information, should 21st Century invest in Project Z today? Explain your answer. 7 8 WACC= 12% 9 Scenario NPV 0 End of time period @t=0 1 1 2 3 2 10% ($500,000) $100,000 $100,000 $100,000 4 $100,000 5 43 $100,000 $3,000,000 $1,562,758.19 44 45 90% ($500,000) $100,000 $100,000 $100,000 $100,000 46 $100,000 ($1,000,000) Will not do -$139,522.38 47 48 Project NPV 49 50 If it turns out that the project at Year 5 has a negative NPV of future opportunities, the firm will not 51 pursue them. Therefore, the cash flows for that branch of the decision tree include only the 52 $500,000 outlay and the $100,000 inflows. Therefore, the expected NPV of Project Z is 153 (0.10)($1,562,758.19)+(0.9)(-$139,522.38) = $30,705.68. Therefore, Project Z has a positive NPV so 154 the firm should invest in it today. 155
Expert Answer:
Related Book For
Fundamentals of Financial Management
ISBN: 978-0324597707
12th edition
Authors: Eugene F. Brigham, Joel F. Houston
Posted Date:
Students also viewed these finance questions
-
21st Century Educational Products (21st Century) is a rapidly growing software company; and consistent with its growth, it has a relatively large capital budget. While most of the companys projects...
-
a. In recent months, Keller?s group has focused on real option analysis.1. What is real option analysis?2. What are some examples of projects with real options?b. Considering real options, one of...
-
John and Adam exchange offices in a transaction that qualifies as a like-kind exchange. As part of the transaction, Adam gives John a truck. In addition, Adam agrees to assume a $20,000 liability...
-
If f, g are continuous functionals on a metric space X, then f + g is continuous f is continuous for every R Therefore the set of all continuous functionals on X is a linear space.
-
1. Is it appropriate for baseball managers to use only quantitative, objective criteria in evaluating their players? What do you think? Why? 2. Describe how baseball front office executives and...
-
Suppose a rope that is hanging by one end from the ceiling has a large inertia. Is the tension in the rope uniform throughout the length?
-
The comparative balance sheets for Rothlisberger Company as of December 31 are presented below. Additional information: 1. Operating expenses include depreciation expense of $42,000 and charges from...
-
The expected returns and standard deviation of returns for two securities are as follows: X Y 15% 15% Standard deviation 10% 20% Expected return Assume that the correlation between the returns of the...
-
Consider a scenario of a four-firm supply chain consisting of a retailer, wholesaler, manufacturer, and supplier. The following table represents the orders placed by each firm in a supply chain. Week...
-
e How was the culture of entrepreneurship and innovation nurtured at 3M from the era of McKnight through to that of DeSimone? How has entrepreneurship been institutionalized within the company? What...
-
During the fiscal year ending March, 31, 20X1, Contract B incurred $10,000,000 of direct labor dollars and total cost input (excluding G&A) of $30,000,000. The cost of money factor for overhead,...
-
You have $5,100 to deposit. Regency Bank offers 12 percent per year compounded monthly (1.0 percent per month), while King Bank offers 12 percent but will only compound annually. How much will your...
-
E15-25. (20 minutes) a. Using the average forward PE ratio for MSI and ERIC of 14.08, the estimated intrinsic value for Nokia is $3.94, computed as 14.08 x $0.28. b. Nokia's actual share price of...
-
The system data for a load flow solution are given below. Determine the voltages by Newton-Raphson method Line admittances Bus Specifications Bus code Admittance Bus code P Q V Remarks 1-2 2-j8 1 -...
-
Respond that the following statements are TRUE or FALSE: 1) When raw materials are purchased on account, the Accounts Payable account is credited. 2) The Raw Materials Inventory account is debited...
-
Les has collected stamps in his spare time for years. He purchased many of his stamps at a price much lower than the current market value. Les recently lost his job as a carpenter. Since his wife...
-
The following information is available for McKee Corporation for 2015. 1. Excess of tax depreciation over book depreciation, 40,000. This 40,000 difference will reverse equally over the years...
-
In 2015, Amirante Corporation had pretax financial income of $168,000 and taxable income of $120,000. The difference is due to the use of different depreciation methods for tax and accounting...
-
Brennan Corporation began 2015 with a $90,000 balance in the Deferred Tax Liability account. At the end of 2015, the related cumulative temporary difference amounts to $350,000, and it will reverse...
Study smarter with the SolutionInn App