If each outcome is equally likely, what is expected NPV? (Negative amount should
ID: 2720567 • Letter: I
Question
If each outcome is equally likely, what is expected NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in dollars not in millions. Round your answer to the nearest dollar amount.)
Will the firm accept the project?
Suppose now that the firm can abandon the project and sell off the manufacturing equipment for $5.58 million if demand for the balls turns out to be weak. The firm will make the decision to continue or abandon after the first year of sales. What is expected NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in dollars not in millions. Round your answer to the nearest dollar amount.)
Does the option to abandon change the firm’s decision to accept the project?
Hit or Miss Sports is introducing a new product this year. If its see-at-night soccer balls are a hit, the firm expects to be able to sell 57,000 units a year at a price of $50 each. If the new product is a bust, only 37,000 units can be sold at a price of $45. The variable cost of each ball is $20, and fixed costs are zero. The cost of the manufacturing equipment is $6.2 million, and the project life is estimated at 10 years. The firm will use straight-line depreciation over the 10-year life of the project. The firm’s tax rate is 35%, and the discount rate is 14%. a-1.If each outcome is equally likely, what is expected NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in dollars not in millions. Round your answer to the nearest dollar amount.)
a-2.Will the firm accept the project?
b-1.Suppose now that the firm can abandon the project and sell off the manufacturing equipment for $5.58 million if demand for the balls turns out to be weak. The firm will make the decision to continue or abandon after the first year of sales. What is expected NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in dollars not in millions. Round your answer to the nearest dollar amount.)
b-2.Does the option to abandon change the firm’s decision to accept the project?
Explanation / Answer
1-a) Expected NPV. if the project is a hit is a bust production & sale 57000 37000 contribution earned at $30 per unit 1710000 at $25 per unit 925000 less depreciation 620000 620000 profit before tax 1090000 305000 tax @ 35% 381500 106750 profit after tax 708500 198250 add depreciation 620000 620000 yearly CFs after tax 1328500 818250 pvifa @ 14%, 10yrs 5.2161 5.2161 pv of cash inflows 6929589 4268074 less: Initial investment 6200000 6200000 NPV 729589 -1931926 probability 0.5 0.5 Expected NPV - 729589*0.5+ (-1931926)*0.5 = -601169 a-2) No, the firm will not accept the project as the expected NPV is negative. b-1) if the project is a hit is a bust production & sale 57000 37000 contribution earned at $30 per unit 1710000 at $25 per unit 925000 less depreciation 620000 620000 profit before tax 1090000 305000 tax @ 35% 381500 106750 profit after tax 708500 198250 add depreciation 620000 620000 yearly CFs after tax 1328500 818250 10 years 1 year pvifa @ 14% 5.2161 0.8772 pv of cash inflows 6929589 717763 salvage value 5580000 (no loss or gain) pv of salvage value 4894737 total pv of inflows 6929589 5612500 less: Initial investment 6200000 6200000 NPV 729589 -587500 probability 0.5 0.5 Expected NPV = 729589*0.5 + (-587500*0.5) = 71045 b-2) Yes, the option to abandon changes the decision of the firm as the expected NPV is positive. It can accept the project.
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