Question 1

Wilson's Antiques is considering a project that has an initial cost today of $14,000.The project has a life of 2 years with cash inflows of $9,500 a year.Should Wilson's decide to wait 2 years to commence this project,the initial cost will increase by 3 percent and the cash inflows will increase to $11,000 a year.What is the value of the option to wait if the applicable discount rate is 12 percent?

Accepted Answer

NPV _Current = -$14,000 + $9,500[(1 - 1 / 1.12²)/ 0.12] = $2,055.48 NPV _Wait = {(-$14,000 × 1.03)+ $11,000[(1 - 1 / 1.12²)/ 0.12]} / 1.12² = $3,324.75 Value of option to wait = $3,324.75 - $2,055.48 = $1,269.26

Question 2

A project has an accounting breakeven point of 3,800 units.The fixed costs are $3,208,and the projected variable cost per unit is $16.42.The project requires an initial investment in fixed assets of $840 that will be depreciated straight-line to zero over the 4-year life of the project.What is the projected sales price given a zero tax rate?

Accepted Answer

3,800 = [$3,208 + ($840 / 4)] / ($P - 16.42) P = $17.32

Question 3

Rizzo's is considering a project with a life of 5 years and an initial cost of $131,000.The discount rate for the project is 14 percent.The firm expects to sell 2,100 units a year.The cash flow per unit is $23.The firm will have the option to abandon this project after 3 years at which time it expects it could sell the project for $49,000.At what level of sales should the firm be willing to abandon this project?

Accepted Answer

$49,000 = ($23 × Q)[(1 - 1 / 1.14^5-3)/ 0.14] Q = 1,294 units

Question 4

Arvin's is analyzing a project with an initial cost of $212,000 that would be depreciated straight-line to zero over the project's 3-year life.Estimates include fixed costs of $48,280,variable costs per unit of $13.12,and a selling price of $26.50 per unit.The discount rate is set at 16 percent with a tax rate of 35 percent.What is the financial breakeven point?

Accepted Answer

NPV = $212,000 = EAC(1 - 1 / 1.16³)/ 0.16 EAC = $94,394.67 Financial breakeven point = [$94,394.67 + $48,280(1 - 0.35)- ($212,000 / 3)(0.35)] / [($26.50 - $13.12)(1 - 0.35)] = 11,618 units

Question 5

ELK,Inc.has compiled this information for a proposed project: sales price = $89 ±3 percent; fixed costs = $21,800 ±1 percent; variable cost per unit = $42.90 ±3 percent; sales quantity = 1,500 units ±5 percent; tax rate = 34 percent; initial investment in fixed assets = $36,500; depreciation method = straight-line to a zero book value over the project's life; project life = 4 years; salvage value of fixed assets = $0; net working capital requirement = $4,800,which will be recouped at the end of the project; discount rate = 12 percent.What is the project's net present value for the pessimistic scenario?

Accepted Answer

OCF_Pessimistic = {(1,500 × 0.95)× [($89 × 0.97)- ($42.90 × 1.03)] - ($21,800 × 1.01)} × (1 - 0.34)+ [($36,500 / 4)× 0.34] = $28,206.11 NPV = -$36,500 - $4,800 + $28,206.11[(1 - 1 / 1.12⁴)/ 0.12] + $4,800 / 1.12⁴ = $47,422.30

Question 6

A proposed project has fixed costs of $159,800,depreciation expense of $47,920,and a sales quantity of 6,750 units.Ignore taxes.What is the contribution margin if the projected level of sales is the accounting breakeven point?

Accepted Answer

Contribution margin _{Accounting breakeven} = ($159,800 + $47,920)/ 6,750 = $30.77

Question 7

A project has a contribution margin of $13.27,projected fixed costs of $78,900,projected variable cost per unit of $9,and a projected financial breakeven point of 16,230 units.The depreciation expense is $36,200,and the tax rate is 35 percent.What is the operating cash flow at this level of output?

Accepted Answer

Operating cash flow_{Financial Breakeven} = [(16,230 × $13.27)- $78,900](1 - 0.35)+ ($36,200 × 0.35)= $101,376.87

Question 8

You are considering a project that has been assigned a discount rate of 12 percent.If you start the project today,you will incur an initial cost of $280 and will receive cash inflows of $350 a year for 3 years.If you wait 1 year to start the project,the initial cost will rise to $420 and the cash flows will increase to $385 a year for 3 years.What is the value of the option to wait?

Accepted Answer

NPV _Current = -$280 + $350[(1 - 1 / 1.12³)/ 0.12] = $560.64 NPV _Wait= {-$420 + $385[(1 - 1 / 1.12³)/ 0.12]} / 1.12 = $450.63 Value of option to wait = $450.63 - $560.64 = -$110.01

Question 9

Assume a project has estimated fixed costs of $61,200,variable costs per unit of $84.29,a selling price of $199,and an initial cost of $402,000 for fixed assets.Depreciation is straight-line to zero over the project's 4-year life.The tax rate is 30 percent,and the discount rate is 12 percent.What is the financial breakeven point?

Accepted Answer

$402,000 = EAC(1 - 1 / 1.12⁴)/ 0.12 EAC = $132,352.24 Financial breakeven point = [$132,352.24 + $61,200(1 - 0.30)- ($402,000 / 4)(0.30)] / [($199 - $84.29)(1 - 0.30)] = 1,806 units

Question 10

Rita's Flowers is considering a 3-year project with a discount rate of 12 percent,a tax rate of 34 percent,and an initial cost of $12,000 for fixed assets.The selling price is estimated at $22 a unit based on variable costs per unit of $6.20 and fixed costs of $2,280.Depreciation is straight-line to zero over 3 years.What is the accounting breakeven point?

Accepted Answer

Accounting breakeven point = {[$2,280 + ($12,000 / 3)](1 - 0.34)} / [($22 - $6.20)(1 - 0.34)] = 397 units

Question 11

The Short Stack expects to sell 8,000 units,±2 percent.The expected variable cost per unit is $8,±3 percent,and the expected fixed costs are $20,000,±1 percent.The depreciation expense is $6,000.The sale price is estimated at $23 a unit,±2 percent.What is the sales revenue under the optimistic case scenario?

Accepted Answer

Sales revenue _Optimistic = 8,000 × 1.02 × $23 × 1.02 = $191,433.60

Question 12

Rosita's is considering a project with a discount rate of 9 percent.If the firm starts the project today,it will incur an initial cost of $32,260 and will receive cash inflows of $18,320 a year for 4 years.If the firm waits 1 year to start the project,the initial cost will decrease to $30,500,the cash flows will increase to $18,640 a year for 4 years,and the discount rate will decrease to 8.5 percent.What is the value of the option to wait?

Accepted Answer

NPV _Current= -$32,260 + $18,320[(1 - 1 / 1.09⁴)/ 0.09] = $27,091.67 NPV _Wait = {-$30,500 + $18,640[(1 - 1 / 1.085⁴)/ 0.085]} / 1.085 = $28,163.25 Value of option to wait = $28,163.25 - $27,091.67 = $1,071.58

Question 13

You are considering a new project with depreciation of $974,fixed costs of 11,580,and a sales price of $14.99.The variable cost per unit is $6.92.Ignore taxes.What is the accounting breakeven level of production?

Accepted Answer

Accounting break-even point = ($11,580 + $974)/ ($14.99 - $6.92)= 1,555.64 units

Question 14

The Tall Stack expects to sell 3,000 units,±10 percent.The expected variable cost per unit is $7,±3 percent,and the expected fixed costs are $13,700,±1 percent.The depreciation expense is $6,870.The sale price is estimated at $16 a unit,±2 percent.The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $15.What will be the earnings before interest and taxes?

Accepted Answer

EBIT = [3,000($15 - $7)] - $13,700 - $6,870 = $3,430

Question 15

The accounting breakeven production quantity for a project is 7,209 units.The fixed costs are $34,780,and the contribution margin is $11.Assume a zero tax rate.What is the projected depreciation expense?

Accepted Answer

Depreciation _{Accounting breakeven}= (7,209 × $11)- $34,780 = $44,519

Question 16

Denver Mart is considering a project with a life of 5 years and an initial cost of $136,000.The discount rate is 11 percent.The firm expects to sell 2,200 units a year with a cash flow per unit of $26.The firm will have the option to abandon this project after 3 years at which time it expects it could sell the project for $48,000.The firm is interested in knowing how the project will perform if the sales forecast for Years 4 and 5 of the project are revised such that there is a probability of 50 percent that the sales will be 1,000 units and a probability of 50 percent they will be 2,500 units a year.What is the net present value of this project given your sales forecasts?

Accepted Answer

$48,000 = ($26 × Q)[(1 - 1 / 1.11^5-3)/ 0.11] Q = 1,078.03 units At 1,000 units,you will abandon the project at the end of Year 3 and receive $48,000. At 2,500 units,you will continue the project for the last two years. NPV₃ = (2,500 × $26)[(1 - 1 / 1.11^5-3)/ 0.11] = $111,314.02 NPV₀= -$136,000 + (2,200 × $26)[(1 - 1 / 1.11³)/ 0.11] + [($48,000 + $111,314.02)/ 2] / 1.11³ NPV₀= $62,025

Question 17

Kurt's Coffees has a new hot drink in mind that is expected to generate sales of 24,000 units over its 2-year life.The initial cost for equipment is $69,500.This equipment will be depreciated straight-line to zero over 2 years and have no salvage value.The fixed costs are $17,800,and the contribution margin is $2.20.The tax rate is 35 percent,and the discount rate is 14 percent.Should this new drink be pursued? Why or why not?

Accepted Answer

$69,500 = EAC(1 - 1 / 1.14²)/ 0.14 EAC = $42,206.64 Financial breakeven point = [$42,206.64 + $17,800(1 - 0.35)- ($69,500 / 2)(0.35)] / $2.20(1 - 0.35)= 29,101 units

Question 18

Isabelle is reviewing a project with projected sales of 1,500 units a year,a cash flow of $38 a unit,and a project life of 4 years.The initial cost of the project is $87,000.The relevant discount rate is 12 percent.She has the option to abandon the project after 1 year at which time she feels she could sell the project for $50,000.At what level of sales should she be willing to abandon the project?

Accepted Answer

$50,000 = (Q × $38)[(1 - 1 / 1.12^4-1)/ 0.12] Q = 548 units

Question 19

Miller Tools is considering a new project that requires an initial investment of $81,300 for fixed assets,which will be depreciated straight-line to zero over the project's 3-year life.The project is expected to have fixed costs of $37,600 a year,and a contribution margin of $18.40.The tax rate is 34 percent and the discount rate is 15 percent.What is the financial breakeven point?

Accepted Answer

$81,300 = EAC[(1 - 1 / 1.15³)/ 0.15] EAC = $35,607.53 Financial breakeven point = [$35,607.53 + $37,600(1 - 0.34)- ($81,300 / 3)(0.34)] / $18.40(1 - 0.34)= 4,217 units

Question 20

Mosler Company is considering a project requiring an initial investment of $229,700,fixed costs of $71,900,variable costs of $5.07 per unit,a selling price of $13.07 per unit,and a life of 4 years.The discount rate is 14 percent,and the tax rate is 30 percent.Depreciation is straight-line to zero over the project's life.What is the accounting breakeven point?

Accepted Answer

Accounting breakeven point = {[$71,900 + ($229,700 / 4)](1 - 0.30)} / [($13.07 - $5.07)(1 - 0.30)] = 16,166 units

Quiz 9: Risk Analysis, Real Options, and Capital Budgeting

A proposed project has fixed costs of $159,800,depreciation expense of $47,920,and a sales quantity of 6,750 units.Ignore taxes.What is the contribution margin if the projected level of sales is the accounting breakeven point?

A project has a contribution margin of $13.27,projected fixed costs of $78,900,projected variable cost per unit of $9,and a projected financial breakeven point of 16,230 units.The depreciation expense is $36,200,and the tax rate is 35 percent.What is the operating cash flow at this level of output?

You are considering a new project with depreciation of $974,fixed costs of 11,580,and a sales price of $14.99.The variable cost per unit is $6.92.Ignore taxes.What is the accounting breakeven level of production?

The accounting breakeven production quantity for a project is 7,209 units.The fixed costs are $34,780,and the contribution margin is $11.Assume a zero tax rate.What is the projected depreciation expense?