Problem 1:
The Best Manufacturing Company is considering a new investment. Financial projections for the investments are tabulated below. Cash flows are in $ thousands, and the corporate tax rate is 34 percent. Assume all sales revenue is received in cash, all operating cost and income taxes are paid in cash, and all cash flows occurs at the end of the year
Year 0 Year 1 Year 2 Year 3 Year 4
Investment 10,000 - - - -
Sales revenue - 7,000 7.000 7,000 7,000
Operating cost - 2,000 2,000 2,000 2,000
Depreciation - 2,500 2,500 2,500 2,500
Net working 200 250 300 200 -
Capital (end of yr)
a. Compute the incremental net, income of the investment for each year.
b. Compute the incremental cash flows of the investment for each year.
c. Suppose the appropriate discount rate is 12 percent. What is the NPV of the project?
Problem 2: Applied Nanotech is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that Applied Nanotech can sell 10 units per year at $0.3 million net cash flow per unit for the nest five years. The engineering department has come up with the estimate that developing the machine will take $10 million initial investment. The finance department has estimated that 25 percent discount rate should be used.
a. What is the base case NPV.
b. If unsuccessful, after the first year the project can be dismantled and sole for scrap for $5 million. Also, after the first year, expected cash flows will be revised up to 20 units per year or to 0 units, with equal probability, if so, what is the option value of abandonment? What is the revised NPV?