ACCT 201 Lecture Notes - Lecture 8: 401(K), Financial Adviser, Cash Flow

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2 Feb 2017

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Questions: present value of a perpetuity. (this covers content covered at the end of the cpa. Pv = cf / r 24,000 / . 06 = ,000. The interest rate is 6%: present value of a mixed stream of payments. Consider the mixed streams of payments shown in the following table: Assume the payments are made at the beginning of each year: find the present value of cash flow stream a using a 15% discount rate. Pv for a = ,533. 42: find the present value of cash flow stream b using a 15% discount rate. Pv for b =,595. 90: compare the calculated present values and discuss them in light of the undiscounted cash flows totaling ,000 in each case. Cash flow stream a provides a larger present value as compared to cash flow. Equivalent to an annuity with a start date in a subsequent year;

Related Questions

1.Acompany borrowed $50,000 cash from the bank and signed a 6-yearnote at 7%. The present value of an annuity for 6 years at 7% is4.7665. The annual annuity payments equal (closest to):

$47,550.00.

2. A corporation declared and issued a 15% stock dividend onNovember 1. The following information was available immediatelyprior to the dividend:

Retained earnings	$750,000
Shares issued and outstanding	60,000
Market value per share	$15
Par value per share	$5

The amount that the total stockholders' will increase (decrease) asa result of recording this stock dividend is:

$0.

3.A company's sales in Year 1 were $250,000 and in Year 2 were$287,500. Using Year 1 as the base year, the sales trend percentfor Year 2 is:

13%.

4.A company uses the weighted average method for inventory costing.During a period, a production department had 20,000 units inbeginning goods in process inventory which were 40% complete; thedepartment completed and transferred 165,000 units. At the end ofthe period, 22,000 units were in the ending goods in processinventory and are 75% complete. All of these are with respect tolabor. The production department had labor costs in the beginninggoods is process inventory of $99,000 and total labor costs addedduring the period are $726,825. Compute the equivalent cost perunit for labor.

$4.61.

5.A company manufactures and sells a product for $120 per unit. Thecompany's fixed costs are $68,760, and its variable costs are $90per unit. The company's break-even point in units is:

840.

6.Stritch Company is trying to decide how many units of merchandiseto order each month. The company's policy is to have 20% of thenext month's sales in inventory at the end of each month. Projectedsales for August, September, and October are 30,000 units, 20,000units, and 40,000 units, respectively. How many units must bepurchased in September?

28,000.

7.A company is considering the purchase of a new piece of equipmentfor $90,000. Predicted annual cash inflows from this investment are$36,000 (year 1), $30,000 (year 2), $18,000 (year 3), $12,000 (year4) and $6,000 (year 5). The payback period is:

	4.50 years.
	4.25 years.
	3.50 years.
	3.00 years.
	2.50 years.

champagnecrocodile942

82.

The Pan American Bottling Co. is considering the purchase of anew machine that would increase the speed of bottling and savemoney. The net cost of this machine is $57,000. The annual cashflows have the following projections. Use Appendix B and Appendix Dfor an approximate answer but calculate your final answer using theformula and financial calculator methods.

Year	Cash Flow
1	$	21,000
2		24,000
3		28,000
4		14,000
5		9,000

a. If the cost of capital is 11 percent, what isthe net present value of selecting a new machine? (Do notround intermediate calculations and round your final answer to 2decimal places.)

b. What is the internal rate of return?(Do not round intermediate calculations. Enter your answeras a percent rounded to 2 decimal places.)

28.

The Bradley Corporation produces a product with the followingcosts as of July 1, 20X1:


Material	$1per unit
Labor	3 per unit
Overhead	2 per unit

Beginning inventory at these costs on July 1 was 3,050 units.From July 1 to December 1, 20X1, Bradley produced 12,100 units.These units had a material cost of $2, labor of $4, and overhead of$2 per unit. Bradley uses LIFO inventory accounting.

a. Assuming that Bradley sold 13,200 unitsduring the last six months of the year at $13 each, what is itsgross profit?

b. What is the value of ending inventory?

30.

The Denver Corporation has forecast the following sales for thefirst seven months of the year:


January	$	22,000	May	$	22,000
February		24,000	June		28,000
March		26,000	July		30,000
April		32,000

Monthly material purchases are set equal to 25 percent offorecast sales for the next month. Of the total material costs, 35percent are paid in the month of purchase and 65 percent in thefollowing month. Labor costs will run $5,200 per month, and fixedoverhead is $8,000 per month. Interest payments on the debt will be$4,200 for both March and June. Finally, the Denver salesforce willreceive a 1.50 percent commission on total sales for the first sixmonths of the year, to be paid on June 30.

Prepare a monthly summary of cash payments for the six-month periodfrom January through June. (Note: Compute prior December purchasesto help get total material payments for January.)

taupesardine251

Real Options

The assignment is to evaluate both parts, the traditional NPVcalculation as well as the Real Options approach.

Scenario: A company must decide whether to invest $100 millionin developing and implementing a new enterprise system in the faceof considerable technological and market (demand for product andmarket share) uncertainty. The firm's cost of capital is 10%.

Part 1.â¨

The probability of a successful project (or pilot) is now .7 andthe probability of an unsuccessful project is .3.

Good Result: The Free Cash flow perpetuity (Annual Benefits) inthe âgoodâ case is $15 million per year

Bad Result: The system proves to be more difficult to implementand improvements in management of the supply chain are less. Inaddition, the growth in market demand for the product is lower. TheFree Cash flow perpetuity (Annual Benefits) in the "bad" case isnow $1.5 million per year, not $2 million.

Given: Year 0 (now) cash flows: $-100 million for ERP purchaseand implementation.

The cost of capital is .1. Use this to calculate the PV of theâgoodâ perpetuity and the PV of the âbadâ perpetuity. Thencalculate the âgoodâ NPV and the âbadâ NPV. Finally calculate theExpected NPV and decide if you will invest.

Part 2.â¨

The real options alternative allows for flexibility and thedelay of the investment for 1 year. In this case, if we do a pilotproject we will be better able to evaluate ERP implementationcomplexities, achievable supply chain benefits, and the marketshare our products will achieve. However, the cost of the projectwill rise to $110 Million ($10 Million this year and $100 Millionnext year) with the one-year delay and additionally managementdecides to purchase and implement the financial module in year 1 ata cost of $10 Million (real option).

The results are slightly different:

Year 0 (now) cash flows: $10 million for the pilot project.

After year 1, if the conditions indicate a good result, the firmwill invest the $100 million for the ERP with expected benefits(cash flows) of $15 million annually (forever) beginning in year 2.Benefits in year one from the financial module are $1 million.

If a bad result is indicated, the firm makes no furtherinvestments beyond the financial module, which yield annualbenefits of $.5 million in year 1 and each year thereafter(forever).

Here the firm has flexibility and has exercised its option tomake no further investments based on better information andknowledge of expected future benefits.

Evaluate the expected NPV of this project using the describedreal option.

Consider that we have the opportunity to do a pilot program byinstalling the financial model only at a cost of $10 MM. A yearfrom now, we can decide whether to invest in the full plant or not.Analyze this case as follows: Find the good case NPV and the badcase NPV. Obviously, we won't exercise the option if we discoverthat we're in the Bad Case. So, we limit our loss to $10 MM lessthe present value of the bad case starting in Year 1.

Part 3.â¨

What is the expected NPV in each case? Compare the

expected NPV using the traditional NPV approach with theexpected NPV using real options. What do you recommend? Why? Whatdo you conclude in each case?

If you don't know the probability of success for the pilot, isthere a value that is critical to your recommendation? Is there aprobability of success above or below which you will recommendundertaking the pilot and below or above which you will recommend ago/ no go decision on the underlying project without undertaking apilot test? â¨â¨

Label your work as follows:

Part 1: NPV Analysisâ¨

1. PV of "Good" perpetuity:â¨

2. PV of "Bad" perpetuityâ¨

3. "Good" NPV:â¨

4. "Bad" NPV:â¨

5. Expected NPV: â¨

6. Invest or don't invest:

Part 2: Real Options Approachâ¨

1. Good case NPV by installing the financial module.â¨

2. Bad case NPV by installing the financial module.â¨

3. Expected NPV by installing the financial module.â¨

4. Should we go ahead with the financial module pilot project orthe full project? â¨

5. Should we undertake both the full project and the pilot"today"?

Part 3: Critical Probabilitiesâ¨

1. Probability to forget the Pilot and complete the Project. Wecan find that probability by equating the present values of thefull project and thepilot. â¨

2. Probability of going ahead with the Pilot. We can calculatethe critical probability for going ahead with the pilot by settingthe PV expression = 0 and solving for X.â¨

3. If there is no real option, breakeven probability for go/nogo.â¨

ACCT 201 Lecture Notes - Lecture 8: 401(K), Financial Adviser, Cash Flow

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