1. (Relevant cash flows) Captins' Cereal is considering introducing a variation of its current breakfast cereal, Crunch Stuff. The new cereal will be similar to the old with the exception that it will contain sugarcoated marshmallows shaped in the form of stars and will be called Crunch Stuff n' Stars. It is estimated that the sales for the new cereal will be $23 million; however, 25 percent of those sales will be former Crunch Stuff customers who have switched to Crunch Stuff n' Stars but who would not have switched if the new product had not been introduced.

What is the relevant sales level to consider when deciding whether to introduce Crunch Stuff n' Stars?

2. (Calculating free cash flows) Spartan Stores is expanding operations with the introduction of a new distribution center. Not only will sales increase but investment in inventory will decline due to increased efficiencies in getting inventory to showrooms. As a result of this new distribution center, Spartan expects a change in EBIT of $1,000,000. Although inventory is expected to drop from $88,000 to $65,000, accounts receivables are expected to climb as a result of increased credit sales from $90,000 to $100,000. In addition, accounts payable are expected to increase from $65,000 to $88,000. This project will also produce $250,000 of bonus depreciation in year 1 and Spartan Stores is in the 32 percent marginal tax rate. What is the project's free cash flow in year 1?

The project's free cash flow in year 1 is $enter your response here. (Round to the nearest dollar.)

3. (Risk-adjusted NPV) The Hokie Corporation is considering two mutually exclusive projects. Both require an initial outlay of $14,000 and will operate for 8 years. Project A will produce expected cash flows of $3,000 per year for years 1 through 8, whereas project B will produce expected cash flows of $4,000 per year for years 1 through 8. Because project B is the riskier of the two projects, the management of Hokie Corporation has decided to apply a required rate of return of 19 percent to its evaluation but only a required rate of return 11 percent to project A. Determine each project's risk-adjusted net present value.

What is the risk-adjusted NPV of project A? (Round to the nearest cent.)

4. (Real options and capital budgeting) You have come up with a great idea for a Tex-Mex-Thai fusion restaurant. After doing a financial analysis of this venture, you estimate that the initial outlay will be $5.7 million. You also estimate that there is a 50 percent chance that this new restaurant will be well received and will produce annual cash flows of $780,000 per year forever (a perpetuity), while there is a 50 percent chance of it producing a cash flow of only $180,000 per year forever (a perpetuity) if it isn't received well.

a. What is the NPV of the restaurant if the required rate of return you use to discount the project cash flows is 10 percent?

b. What are the real options that this analysis may be ignoring?

c. Explain why the project may be worthwhile even though you have just estimated that its NPV is negative?