Exam 10: Project Analysis

The accounting break-even point occurs when:

Firms that use break-even on an accounting basis are really losing the opportunity cost of capital on their investments.

Briefly explain the term "real options."

A project requires an initial investment in equipment of $90,000 and then requires an investment in working capital of $10,000 at the beginning (t = 0). The project is expected to produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be 60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the cost of capital is 15%. Cash flows from the project are:

You are given the following data for year-1: Revenues = 100, Fixed costs = 30; Total variable costs = 50; Depreciation = $10; Tax rate = 30%. Calculate the after tax cash flow for the project for year-1.

Define the term "abandonment value."

Generally, postaudits are conducted for large projects:

A project requires an initial investment in equipment of $90,000 and then requires an investment in working capital of $10,000 at the beginning (t = 0). The project is expected to produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be 60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the cost of capital is 15%. What would the NPV if the discount rate were higher by 10%?

KMW Inc. sells a finance textbook for $150 each. The variable cost per book is $30 and the fixed cost per year is $30,000. The process of creating a textbook costs $150,000 and the average book has a life span of 3 years. Using straight line depreciation and a tax rate of 25%, What is the accounting break even number of books that must be sold?

The break-even point in terms of NPV is usually lower than the break-even point on an accounting basis.

A project has the following cash flows: C0 = -100,000; C1 = 50,000; C2 = 150,000; C3 = 100,000. If the discount rate changes from 12% to 15%, what is the change in the NPV of the Project (approximately)?

The following are real options except:

Postaudits are conducted before the start of the projects.

Hammer Company proposes to invest $6 million in a new type of hammer-making equipment. The fixed costs are $1.0 million per year. The equipment is expected to last for five years. The manufacturing cost per hammer is $1 and the selling price per hammer is $6. Calculate the break-even volume per year. (Ignore taxes.)

You are planning to produce a new action figure called "Hillary". However, you are very uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50 million per year for 3 years (starting next year). If it fails, you will only have net cash flows of $10 million per year for 2 years (starting next year). There is an equal chance that it will be a hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the first year's cash flows are in. You have to spend $80 million immediately for equipment and the rights to produce the figure. If the discount rate is 10%, calculate the NPV without the abandonment option.

Briefly describe sensitivity analysis used for project analysis.

Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per year forever. The risk-free rate is 10% per year, which is also the cost of capital (Ignore Taxes). Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year and then expected NPV of the project if postponed by one year is:

A project has an initial investment of $150. You have come up with the following estimates of revenues and costs. Calculate the NPV assuming that cash flow and perpetuities. (No taxes.) (Cost of capital = 10%)

You are given the following data for year-1. Revenue = $43; Total costs = $30; Depreciation = $3; Tax rate = 30%. Calculate the operating cash flow for the project for year- 1)

Discounted cash flow (DCF) analysis generally: I. assumes that firms hold assets passively when it invests in a project II. considers opportunities to expand a project if the project is successful III. considers opportunities to abandon a project if the project is a failure