When preparing capital budgeting analysis for a new project, Chris Johnson, a chief financial officer at...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
When preparing capital budgeting analysis for a new project, Chris Johnson, a chief financial officer at BT Industries, faced a dilemma. The project involved a production of new type of shipping containers, which were significantly more durable and had a considerably longer useful life compared to conventional containers used in the industry. The year was 2021, and the equipment necessary for producing the containers was being sold for $750K. Each year, this cost is expected to increase by 30%. The useful life of the equipment and the project is 6 years. Mr. Johnson estimated that during a recovery year, the project will generate net cash flows of $500K per year, while during a recessionary year, the project will lose money, with an expected net cash flow of $-100K per year. Because the economy suffered a significant decline during the year, there was uncertainty about the economy in general, and, very much affected by the economy, the demand for shipping and containers. Market analysts predicted that 2022 provide certain information about the likelihood of recovery. At this point, in 2021, the likelihood of 2022 being a recovery year is estimated at 45% and the likelihood of 2022 being a recession year is estimated at 55%. If 2022 is a recovery year, the likelihood that recovery continues in 2023 and all subsequent years is 80%, and the likelihood of these subsequent years being recessionary years is 20%. If recession continues in 2022, the likelihood that 2023 and all subsequent years will be recovery years is 30%, and the likelihood of these subsequent years being recessionary is 70%. In 2023, the market gets resolved, and whatever state of the economy was in 2023 will continue the foreseeable future with certainty. The management identified that they need to invest in the project in the next three years, or abandon it forever. That is, they were considering undertaking the investment in 2021, 2022, or 2023. Mr. Johnson has estimated that the WACC for the company in certain times has been 10%. Assume that the project has no tax implications, i.e. the tax rate of 0%. Also assume that the firm can shut down the project any time at a one-time cost of $20K. What strategy with respect to this investment will generate the highest value for the firm? In other words, when should the firm invest and under what circumstances? To answer this question, a) evaluate the NPV of investing in 2021, in 2022, and in 2023, and b) carefully think about how you can combine the information obtained in these estimations to identify the most value-increasing strategy. When preparing capital budgeting analysis for a new project, Chris Johnson, a chief financial officer at BT Industries, faced a dilemma. The project involved a production of new type of shipping containers, which were significantly more durable and had a considerably longer useful life compared to conventional containers used in the industry. The year was 2021, and the equipment necessary for producing the containers was being sold for $750K. Each year, this cost is expected to increase by 30%. The useful life of the equipment and the project is 6 years. Mr. Johnson estimated that during a recovery year, the project will generate net cash flows of $500K per year, while during a recessionary year, the project will lose money, with an expected net cash flow of $-100K per year. Because the economy suffered a significant decline during the year, there was uncertainty about the economy in general, and, very much affected by the economy, the demand for shipping and containers. Market analysts predicted that 2022 provide certain information about the likelihood of recovery. At this point, in 2021, the likelihood of 2022 being a recovery year is estimated at 45% and the likelihood of 2022 being a recession year is estimated at 55%. If 2022 is a recovery year, the likelihood that recovery continues in 2023 and all subsequent years is 80%, and the likelihood of these subsequent years being recessionary years is 20%. If recession continues in 2022, the likelihood that 2023 and all subsequent years will be recovery years is 30%, and the likelihood of these subsequent years being recessionary is 70%. In 2023, the market gets resolved, and whatever state of the economy was in 2023 will continue the foreseeable future with certainty. The management identified that they need to invest in the project in the next three years, or abandon it forever. That is, they were considering undertaking the investment in 2021, 2022, or 2023. Mr. Johnson has estimated that the WACC for the company in certain times has been 10%. Assume that the project has no tax implications, i.e. the tax rate of 0%. Also assume that the firm can shut down the project any time at a one-time cost of $20K. What strategy with respect to this investment will generate the highest value for the firm? In other words, when should the firm invest and under what circumstances? To answer this question, a) evaluate the NPV of investing in 2021, in 2022, and in 2023, and b) carefully think about how you can combine the information obtained in these estimations to identify the most value-increasing strategy.
Expert Answer:
Answer rating: 100% (QA)
To evaluate the NPV of the investment in 2021 2022 and 2023 we need to first calculate the expected ... View the full answer
Related Book For
Intermediate Financial Management
ISBN: 9780357516669
14th Edition
Authors: Eugene F Brigham, Phillip R Daves
Posted Date:
Students also viewed these finance questions
-
Read the case study "Southwest Airlines," found in Part 2 of your textbook. Review the "Guide to Case Analysis" found on pp. CA1 - CA11 of your textbook. (This guide follows the last case in the...
-
Managing Scope Changes Case Study Scope changes on a project can occur regardless of how well the project is planned or executed. Scope changes can be the result of something that was omitted during...
-
The Crazy Eddie fraud may appear smaller and gentler than the massive billion-dollar frauds exposed in recent times, such as Bernie Madoffs Ponzi scheme, frauds in the subprime mortgage market, the...
-
If the molecular weight of air is 28.9, what is the density of air at atmospheric pressure and a temperature of 328.2 K? 1 atm = 1.013 x 10 5 N/m, the mass of a proton is 1.67262 x 10 -27 kg,...
-
You intend to use an electron microscope to study the structure of some crystals. For accurate resolution, you want the electron wavelength to be 1.00 nm. (a) Are these electrons relativistic? How do...
-
How can a corporation that has its offices out of state be served?
-
Washing clothes is most similar to large-scale washing when (select the best answer) a. the clothes are washed by hand. b. the clothes are washed with detergent but no soap. c. the clothes are washed...
-
Pan Corporation acquired a 75 percent interest in Saf Corporation on January 1, 2011. Financial statements of Pan and Saf Corporations for the year 2011 are as follows (in thousands): REQUIRED:...
-
Explain the basic logic of discounted dividend approaches to valuing equities
-
Automotive Interiors (AI) manufactures seats for automobiles, vans, trucks, and boats. The company has a number of plants, including the Woodstock Cover Plant, which makes seat covers. Bill Rice is...
-
PhilaFarm just purchased equipment for $430,000. Use the MACRS rates for an equipment classified as a 3-year class asset to find: The equipment's annual depreciation. The annual tax shield associated...
-
How do scholars and practitioners conceptualize the intricate dynamics of the technology cycle, encompassing phases of invention, innovation diffusion, adoption, maturation, and obsolescence, within...
-
What measures should be put in place to control the organization? Somebody has to be in charge. Which one? What mechanisms can they use to make sure that they always knew who's in charge of what in...
-
The light beam shown in the figure below makes an angle of 18.8 with the normal line NN' in the linseed oil. Determine the angles and 0. (The refractive index for linseed oil is 1.48.) 0 = Air...
-
rtment of an Kingston Company produces a hover board with a unit variable cost of $100 and a unit selling price of $176. Fixed manufacturing costs were $24,000 when 8,000 units were produced and...
-
During the cherry tariff what was the exporting price for cherries, and how much money in sales and income did farmers lose due to the cherry tariff in simple sentences?
-
WORKSHEET AND FINANCIAL STATEMENTS The following account balances, before adjustments, were taken from the ledger of John Wick on December 31, 2023. Cash Notes Receivable Accounts Receivable Unused...
-
Read the following description and Write a response of it. The discretion of public administrators can be decreased, but not altogether eliminated. Officials will use their discretion in any given...
-
Start with the partial model in the file Ch09 P11 Build a Model.xlsx on the textbooks Web site, which contains Henley Corporations most recent financial statements. Use the following ratios and other...
-
Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years, and in 2021 Boehm paid dividends of $4 million on net income of $10 million. However, net income is expected to...
-
Dreebyshaw Inc. needed to raise $14 million in an IPO and chose Security Brokers Inc. to underwrite the offering. The agreement stated that Security Brokers would sell 3 million shares to the public...
-
What happens to the oligopolists profits if entry is easy?
-
What is price leadership?
-
In an oligopoly such as the U.S. domestic airline industry, a firm such as United Airlines would a. carefully anticipate Delta, JetBlue, and Southwests likely responses before it raised or lowered...
Study smarter with the SolutionInn App