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essentials managerial finance
Principles Of Managerial Finance 15th Global Edition Chad J. Zutter, Scott Smart - Solutions
=+12–2 Define risk in terms of the cash flows from a capital budgeting project.How can determination of the breakeven cash inflow be used to gauge project risk?
=+12–3 Describe how each of the following behavioral approaches can be used to deal with project risk: (a) scenario analysis and (b) simulation.
=+12–5 Briefly explain how the following items affect the capital budgeting decisions of multinational companies: (a) exchange rate risk; (b) political risk; (c) tax law differences; (d) transfer pricing; and (e) a strategic, rather than a strictly financial, viewpoint.
=+12–6 Describe the basic procedures involved in using risk-adjusted discount rates (RADRs). How is this approach related to the capital asset pricing model (CAPM)?
=+12–8 How are risk classes often used to apply RADRs?
=+12–10 What are real options? What are some major types of real options?
=+12–12 What is capital rationing? In theory, should capital rationing exist?Why does it frequently occur in practice?
=+12–14 Comparing projects with unequal lives is often done by comparing the projects’ annualized net present value. With the information provided at MyLab Finance, use a spreadsheet to compare projects based on their ANPV
=+ST12–1 Risk-adjusted discount rates CBA Company is considering two mutually exclusive projects, A and B. The following table shows the CAPM-type relationship between a risk index and the required return (RADR) applicable to CBA Company.Project data are as follows:
=+a. Ignoring any differences in risk and assuming that the firm’s cost of capital is 10%, calculate the net present value (NPV) of each project.
=+b. Use NPV to evaluate the projects, using risk-adjusted discount rates (RADRs) to account for risk.
=+c. Compare, contrast, and explain your findings in parts a and b.
=+E12–2 Antonio wishes to evaluate a business opportunity that requires an initial investment of €70,000 and is expected to bring positive cash flows for 5 years. What minimum amount of annual cash inflow is needed if he has a 5% cost of capital?If the opportunity is expected to earn €15,000
=+LG 5 E12–4 Kubi Software Inc., based in Turkey, has hired Rezart to advise the firm on a capital budgeting issue involving two unequal-lived, mutually exclusive projects, Gamma and Beta. The cash flows for each project are presented in the following table. Calculate the NPV and the annualized
=+P12–1 Recognizing risk Spin Corp., a media services firm with net earnings of $3,200,000 in the past year, is considering the following projects.The media services business is cyclical and highly competitive. The board of directors has asked you, as chief financial officer, to do the following:
=+a. Evaluate the risk of each proposed project and rank it “low,” “medium,” or “high.”
=+b. Comment on why you chose each ranking.
=+LG 2 P12–2 Breakeven cash inflows The Golden Sling Company, a leading producer of gold-plated jewelry, is considering the purchase of new equipment that will improve the efficiency of its production process. The up-front cost of the equipment is $220,000. The equipment is expected to generate
=+a. Calculate the minimum yearly cash inflow necessary for this investment to be accepted, if the required return on investment is 8%.
=+b. Calculate the minimum yearly cash inflow necessary, if the required return on investment changes to 12%.
=+LG 2 P12–3 Breakeven cash inflows and risk Taiwan Semiconductor Manufacturing Co. Ltd.(TSMC), one of the world’s largest semiconductor foundries, is considering building a new production facility close to one of its main business partners. Once the facility is built, TSMC will be the
=+a. Find the NPV for each project. Are the projects acceptable?
=+b. Find the breakeven cash inflow for each project.
=+c. The company has estimated the probabilities of achieving various ranges of cash inflows for the two projects as shown in the following table. What is the probability that each project will achieve at least the breakeven cash inflow found in part b?Probability of achieving cash inflow in given
=+d. Which project is riskier? Which project has the potentially higher NPV?Discuss the risk-return tradeoffs of the two projects.
=+e. If TSMC wants to minimize losses (i.e., NPV 6 NT$0), which project would you recommend? Which would you recommend if the goal were to achieve a higher NPV?
=+P12–4 Basic scenario analysis Aluminum Projects is in the process of evaluating two new aluminum cutting machines with the intention of purchasing one of them. The firm’s financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows for the
=+a. Determine the range of annual cash inflows for each machine.
=+b. Assume that firm’s cost of capital is 10% and that both machines have 12-year lives. Construct a table similar to this one for the NPVs for each machine.Include the range of NPVs for each machine.
=+c. Based on the range of the cash flows and the NPVs of each machine, which machine should be acquired?
=+d. Which machine should the firm invest in if it is not willing to take risks? Why?
=+LG 2 P12–5 Scenario analysis Novartis International AG, a global healthcare company based in Switzerland, is considering producing either a generic multivitamin or a specific blend of vitamins A, C, and D. Novartis expects both products to provide benefits over a 12-year period, and each has a
=+a. Determine the range of annual cash inflows for each of the two products.
=+b. Construct a table similar to this one for the NPVs associated with each outcome for both products.
=+c. Find the range of NPVs, and subjectively compare the risks associated with these products.
=+d. Which product do you recommend? Why?
=+LG 2 P12–6 Scenario analysis For De Beers, one of the biggest companies in the business of diamond exploration, mining, and trading, when the market price of a single 1 carat round-cut diamond is R59,220 (R stands for South African Rand) the NPV of its Damtshaa mine, in Botswana, is
=+a. Calculate the internal rate of return (IRR) for the diamond mine project if the price of diamond drops 10%.
=+b. Calculate the net present value (NPV) for the diamond mine project if the price of diamond drops 10%.
=+c. Calculate the internal rate of return (IRR) for the diamond mine project if the price of diamond drops 20%.
=+d. Calculate the net present value (NPV) for the diamond mine project if the price of diamond drops 20%.
=+e. Below what price per one carat diamond is De Beers’ decision to reopen the mine no longer acceptable?
=+P12–7 Impact of inflation on investments The Choc Shop is considering buying new equipment with an initial investment outlay of $32,000. The equipment has a 5-year life with cash inflows in years 1 to 5 of $11,500, $12,000, $12,500, $10,000, and$9,500, respectively. The current opportunity
=+a. Calculate the net present value (NPV) of the investment under the current required rate of return.
=+b. Calculate the net present value (NPV) of the investment under a period of rising inflation.
=+c. Calculate the net present value (NPV) of the investment under a period of falling inflation.
=+d. Based on your answers in partsa, b, andc, describe the relationship between changes in inflation and asset valuation.
=+LG 2 P12–8 Simulation Ogden Corporation has compiled the following information on a capital expenditure proposal:(1) The projected cash inflows are normally distributed with a mean of $36,000 and a standard deviation of $9,000.(2) The projected cash outflows are normally distributed with a mean
=+a. Describe how the foregoing data can be used to develop a simulation model for finding the net present value of the project.
=+b. Discuss the advantages of using a simulation to evaluate the proposed project.
=+P12–9 Risk-adjusted discount rates: Basic Mayflower Interiors is considering investing in one of three mutually exclusive projects, X, Y, and Z. The firm’s cost of capital, r, is 13.5% and the risk-free rate, RF, is 10%. The firm has gathered the basic cash flow and risk index data for each
=+a. Find the net present value (NPV) of each project, using the firm’s cost of capital.Which project is preferred in this situation?
=+b. The firm uses the following equation to determine the risk-adjusted discount rate, RADRj, for each project j:RADRj = RF + 3RIj * (r - RF)4 where RF = risk@free rate of return RIj = risk index for project j r = cost of capital Substitute each project’s risk index into this equation to
=+c. Use the RADR for each project to determine its risk-adjusted NPV. Which project is preferable in this situation?
=+d. Based on your answers in parts a andc, which project should the firm accept?Explain your answer.
=+LG 4 P12–10 Risk-adjusted discount rates: Tabular Wentworth Art School is evaluating a few investment alternatives and opportunities. It has developed a CAPM-type relationship linking a risk index to the required return (RADR), as shown in the following table.Risk index Required return
=+The school is considering two mutually exclusive projects. The data that the firm has been able to gather about the projects are shown in the following table. All the cash inflows have already been adjusted for taxes.Painting project Sculpture project Initial investment (CF0) -$25,000 -$35,000
=+a. Evaluate the two projects using risk-adjusted discount rates.
=+b. Discuss your findings in parta, and recommend the preferred project.
=+P12–11 Mutually exclusive investments and risk Diane Smith is interested in two mutually exclusive investments. Both investments have a time horizon of 8 years. The first investment opportunity requires an initial investment of $10,000, to receive equal and consecutive year-end payments of
=+a. Calculate the net present value of the first investment.
=+b. Calculate the net present value of the second investment.
=+c. Being mutually exclusive, which investment should Diane choose? Explain.
=+d. Which investment was relatively more risky? Explain.
=+LG 4 P12–12 Risk-adjusted rates of return using CAPM Roots to Branches Corp., a company specializing in event décor, is considering two mutually exclusive investments. The company wishes to use a CAPM-type risk-adjusted discount rate (RADR) in its analysis. Management expects that the
=+a. Use a risk-adjusted discount rate approach to calculate the net present value of each project, given that the RADR factor for project Roots is 1.40 and for project Branches is 1.60. The RADR factors are similar to project betas. (Refer to Equation 12.5 to calculate the required project return
=+b. Discuss your findings in parta, and recommend the preferred project.
=+LG 4 P12–13 Risk classes and RADR Patek Philippe & Co. is attempting to select one of three mutually exclusive projects for the redesign of its classic watches: Nautilius, Grand Complications, and Calatrava. Although all the projects have 5-year lives, they possess differing degrees of risk.
=+project Grand Complications is in class II, the below-average-risk class; and project Calatrava is in class III, the average-risk class. The basic cash flow data for each project and the risk classes and risk-adjusted discount rates (RADRs) used by the firm are shown in the following tables.
=+Nautilius Grand complications Calatrava Initial investment (CF0) −€180,000 −€235,000 −€310,000 Year (t) Cash inflows (CFt)1 € 80,000 € 50,000 € 90,000 2 70,000 60,000 90,000 3 60,000 70,000 90,000 4 60,000 80,000 90,000 5 60,000 90,000 90,000 Risk Classes and RADRs Risk class
=+a. Calculate the NPV for each machine over its life. Rank them in their order of acceptance on the basis of the NPV.
=+b. Use the annualized net present value (ANPV) approach to evaluate and rank the machines in descending order on the basis of the ANPV.
=+c. Based on your findings in parts a andb, which machine would you recommend that Porter & Sons acquire? Why?
=+a. Find the risk-adjusted NPV for each project.
=+b. Which project, if any, would you recommend that the firm undertake?
=+LG 5 P12–14 Unequal lives: ANPV approach Porter & Sons wishes to select the best of three possible machines, each of which can be used in the firm’s workshop to polish marble. All three machines – A, B, and C – are equally risky. The firm plans to use a 15% cost of capital to evaluate
=+P12–15 Unequal lives: ANPV approach Godiva Chocolatier is considering one of three mutually exclusive projects for opening a chocolate factory in Bruges, Gent, or Liege. The firm plans to use a 10% cost of capital to evaluate these equal-risk projects. The initial investment and annual cash
=+a. Calculate the NPV for each project over its life. Rank the projects in descending order on the basis of NPV.
=+b. Use the annualized net present value (ANPV) approach to evaluate and rank the projects in descending order on the basis of ANPV.
=+c. Compare and contrast your findings in parts a andb. Which project would you recommend that the firm accept? Why?
=+LG 5 P12–16 Unequal lives: ANPV approach Warehouse Systems Enterprises (WSE) has designed a new inventory management system. Management must choose from three alternative courses of action. The firm can: (1) sell the design of the new system outright to a warehouse with payment over 3 years;
=+a. Calculate the NPV of each alternative and rank them in order of acceptability on the basis of NPV.
=+b. Calculate the annualized net present value (ANPV) of each alternative, and rank them accordingly.
=+c. Which alternative should WSE accept? Why?
=+P12–17 NPV and ANPV decisions Richard and Linda Butler decide that it is time to purchase a high-definition (HD) television because the technology has improved and prices have fallen over the past 3 years. From their research, they narrow their choices to two sets, the Samsung 64-inch plasma
=+a. Determine the NPV of the Samsung HD plasma TV.b. Determine the ANPV of the Samsung HD plasma TV.c. Determine the NPV of the Sony HD plasma TV.d. Determine the ANPV of the Sony HD plasma TV.
=+e. Which set should the Butlers purchase? Why?
=+LG 6 P12–18 Real options and the strategic NPV Suppose Dave Marberger, the CFO of Godiva Chocolatier, has just completed an evaluation of a proposed capital expenditure for the expansion of the firm’s chocolate factory in Brussels. Using the traditional NPV methodology, he has found the
=+a. Use the information provided to calculate the strategic NPV, NPVstrategic, for Godiva’s proposed expansion.
=+b. On the basis of your findings in parta, what action should Dave recommend to management with regard to the proposed expansion?
=+c. In general, how does this problem demonstrate the importance of considering real options when making capital budgeting decisions?
=+P12–19 Capital rationing: IRR and NPV approaches Hotel Amazing is attempting to select the best of a group of independent projects competing for the firm’s fixed capital budget of $5.5 million. Management recognizes that any unused portion of this budget will earn less than the 12% cost of
=+a. Use the internal rate of return (IRR) approach to select the best group of projects.
=+b. Use the net present value (NPV) approach to select the best group of projects.
=+c. Are the projects selected in parts a and b the same? Explain your answer.
=+d. Which projects should Hotel Amazing implement? Why?
=+LG 6 P12–20 Capital rationing: NPV approach A firm with a 13% cost of capital must select the optimal group of projects from those shown in the following table, given its capital budget of $1 million.
=+a. Calculate the present value of cash inflows associated with each project.
=+b. Select the optimal group of projects, keeping in mind that unused funds are costly.
=+LG 4 P12–21 ETHICS PROBLEM In less than three decades, China has become the second largest economy in the world. But this rapid growth has led to a lot of environmental and health issues. These developments have placed environmental pollution at the top of the government’s reform agenda.
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