Question

In: Finance

Question 1 A project has a cost of R1.4 million and next year will generate either...

Question 1

A project has a cost of R1.4 million and next year will generate either R2 million or R100,000 with equal probability. Assuming an 8 percent discount rate, what is the NPV of the project based on the expected cash flows next year? If the company could pay R50,000 today for an exclusive right to manufacture the project, this would allow the company to make the R1.4 million investment under conditions of generating R2 million in cash flow, and not manufacture the project under the R100,000 cash flow scenario. Assess the NPV of this exclusive right to manufacture (a type of abandonment option allowing the company to not manufacture under poor conditions) by calculating the profit under both cash flow scenarios:
1.1. R2 million less R1.4 million for the R2 million scenario. (5)
1.2. Zero for the R100,000 cash flow scenario (Note: there is an assumption that the company can manufacture the product immediately and that manufacturing costs do not increase, which may not be realistic). (5)
1.3. Should the company pay R50,000 for the exclusive right to manufacture

Solutions

Expert Solution

Profit/NPV if company Generate R 2 million cash Flow next year :-

a. Cost of Project = R 14,00,000

b. Present Value of Cash Flow = R 20,00,000 * 1/1.08 = R 18,51,852

c NPV/Profit = b-a

= 18,51,852-14,00,000

NPV = R 4,51,852

Profit/NPV if company Generate R 100000 only cash Flow next year :-

a. Cost of Project = R 14,00,000

b. Present Value of Cash Flow = R 1,00,000 * 1/1.08 = R 92,593

c NPV/Profit = b-a = R (13,07,507)

Profit/NPV if company does not invest for Exclusive Right:-

Scnario NPV Probability (P) NPV * P
a. CF = R2M 4,51,852 0.50 2,25,926
b CF = R100000 (13,07,507) 0.50 (6,53,754)
Expected NPV (6,53,754)

Profit/NPV if company invest R 50,000 in Exclusive Rights :-

If CF= R1.4 Million then NPV would be R 4,51,852-50,000 = 4,01,852

However if CF = R 100000 then NPV would be Zero (0) as the company will not be invest in project and expesne of R 50,000 being Sunk Cost will be ignored.

Hence the NPV of Project if Invesrment is made in Exclusive Right will be

Scnario NPV Probability (P) NPV * P
a. CF = R2M 4,01,852 0.50 2,00,926
b CF = R100000 0 0.50 0
Expected NPV 2,00,926

Since there is Positive as well as higher NPV if Company invest in Exclusive right of project it is advisable for the company to invest in project along with investing for exclusive right of the product.

If you find the answer relevant and useful then do always give feedback of answer so that author will come to about quality of its answering.


Related Solutions

A firm has an investment project that will cost the firm $30 million but will generate...
A firm has an investment project that will cost the firm $30 million but will generate $2 million of NPV. Also there is a 5% chance that the firm will lose a lawsuit to employees, and be forced to pay damage of $30 million. Suppose that a liability insurance policy with a $30 million limit has a premium equal to $1.5 million. a. Compute expected claim cost b. Compute the amount of loading on the policy c. Compute the expected...
A firm has an investment project that will cost the firm $30 million but will generate...
A firm has an investment project that will cost the firm $30 million but will generate $2 million of NPV. Also there is a 5% chance that the firm will lose a lawsuit to employees, and be forced to pay damage of $30 million. Suppose that a liability insurance policy with a $30 million limit has a premium equal to $1.5 million. Compute expected claim cost Compute the amount of loading on the policy Compute the expected cost of not...
A flood control project has a construction cost of $10 million in year 1; $6 million...
A flood control project has a construction cost of $10 million in year 1; $6 million in year 2; and $2 million in year 3, when it is completed. Beginning in year 4, annual O&M costs are $200,000/year. The interest rate is 6%. Benefits also begin accruing in year 4, valued at $1.5 million that year. Thereafter, the benefits grow at a uniform rate of $30,000/year until the end of the project life of 50 years. Make a cash flow...
1. A project costs $10 million today. Next year (year 1) the cash inflow will be...
1. A project costs $10 million today. Next year (year 1) the cash inflow will be either $10 million or $2 million with equal probability. If the year-1 cash inflow was $10 million, then the year-2 cash flow will also be $10 million. If the year-1 cash inflow was $2 million, then the year-2 cash flow will also be $2 million. If the firm can abandon the project ONLY after year 1 for a known amount of $3 million at...
A proposed project will generate £150,000 in revenue a year for 20 years (starting next year),...
A proposed project will generate £150,000 in revenue a year for 20 years (starting next year), but will cause another product line to lose £60,000 in revenue a year during that time. The project will make use of 50% of an already leased warehouse with total annual rent of£50,000 (the contract does not prohibit sub-leasing). The discount rate for this project is 6%. Should the firm undertake this project if the required investment is £250,000? What is the Payback Period...
Analyze a project which has an investment cost of$2,000.  Every year, starting next year (t=1), the...
Analyze a project which has an investment cost of $2,000.  Every year, starting next year (t=1), the project will generate $100 in revenue, but it will also incur $30 in expenses.  The project will be considered an on-going project going on forever.  If the cost of financing this project is 6%, then the NPV of the project is what?
A company is forecasted to generate free cash flows of $23 million next year and $25...
A company is forecasted to generate free cash flows of $23 million next year and $25 million the year after. After that, cash flows are projected to grow at a stable rate in perpetuity. The company's cost of capital is 8.4%. The company has $63 million in debt, $19 million of cash, and 15 million shares outstanding. Using an exit multiple for the company's free cash flows (EV/FCFF) of 16, what's your estimate of the company's stock price?
A company is forecasted to generate free cash flows of $23 million next year and $28...
A company is forecasted to generate free cash flows of $23 million next year and $28 million the year after. After that, cash flows are projected to grow at a stable rate in perpetuity. The company's cost of capital is 12.3%. The company has $61 million in debt, $13 million of cash, and 28 million shares outstanding. Using an exit multiple for the company's free cash flows (EV/FCFF) of 19, what's your estimate of the company's stock price? a. 30.8...
Company is projected to generate free cash flows of $179 million per year for the next...
Company is projected to generate free cash flows of $179 million per year for the next 3 years (FCFF1, FCFF2 and FCFF3). Thereafter, the cash flows are expected to grow at a 1.8% rate in perpetuity. The company's cost of capital is 10.9%. What is your estimate for its enterprise value? Answer in millions, rounded to one decimal place
A company is projected to generate free cash flows of $178 million next year and $191...
A company is projected to generate free cash flows of $178 million next year and $191 million at the end of year 2, after which it is projected grow at a steady rate in perpetuity. The company's cost of capital is 13.6%. It has $107 million worth of debt and $77 million of cash. There are 21 million shares outstanding. If the exit multiple for this company's free cash flows (EV/FCFF) is 7.7, what's your estimate of the company's stock...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT