30. The Bull Company, a lawn mower manufacturer, is considering the introduction of a new model. The initial outlay required is $22 million. Net cash flows over the 4-year life cycle and the corresponding certainty-equivalents of the new model are as follows:
Year Net Cash Flow Certainty-equivalent Factor
1 $15 million 0.90
2 $13 million 0.75
3 $11 million 0.55
4 $ 9 million 0.30
The firm's cost of capital is 14% and the risk-free rate is 6%. Bull uses the certainty-equivalent approach in evaluating above-average risk investments such as this one. What is the project's certainty-equivalent NPV?
A. $20,083,000.28
B. $6,631,663.90
C. $13,905,000.72
D. $3,019,400.20
30. The Bull Company, a lawn mower manufacturer, is considering the introduction of a new model. The initial outlay required is $22 million. Net cash flows over the 4-year life cycle and the corresponding certainty-equivalents of the new model are as follows:
Year Net Cash Flow Certainty-equivalent Factor
1 $15 million 0.90
2 $13 million 0.75
3 $11 million 0.55
4 $ 9 million 0.30
The firm's cost of capital is 14% and the risk-free rate is 6%. Bull uses the certainty-equivalent approach in evaluating above-average risk investments such as this one. What is the project's certainty-equivalent NPV?
A. $20,083,000.28
B. $6,631,663.90
C. $13,905,000.72
D. $3,019,400.20
Related questions
BTR Warehousing, which is considering the acquiition of Galaxy Sun Corp., estimates that acquiring Galaxy Sun will result in an incremental value for the firm. The analysts involved in the deal have collected the following information from the projected financial statements of the target company:
Data collected (in millions of dollars)
| Year 1 | Year 2 | Year 3 | |
| EBIT | $14.0 | $16.8 | $21.0 |
| Interest Expense | 4.0 | 4.4 | 4.8 |
| Debt | 31.9 | 37.7 | 40.6 |
| Total net operating capital | 121.5 | 123.9 | 126.3 |
Galaxy Sun Corp. is a publicly traded company, and its market-determined pre-merger beta is 1.20. You also have the following information about the company and the projected statements:
a) Galaxy Sun currently has a $32.00 million market value of equity and $ 20.80 million in debt.
b) The risk-free rate is 4%, there is a 6.10% market risk premium, and the capital aset pricing model purchases a pre-merger required rate of return on equity of 11.32%.
c) Galaxy Sun's cost of debt is 6.00% at a tax rate of 35%.
d) The projections assume that the company will have a post-horizon growth rate of 5.00%.
e) Current total net operating capital is $118.0, and the sum of existing debt and debt required to maintain a constant capital structure at the time of acquisitionis $29 million.
f) The firm does not have any nonoperating assets such as marketable securities.
Given this information, use the adjusted present value (APV) approach to calculate the following values involved in merger analysis:
1. Unlevered cost of equity: 8.10%/ 6.82% / 9.22% / 10.50%
2. Horizontal value of unlevered cash flows: $211.99 million / $279.92 million / $266.59 million / $132.70 million
3. Horizontal value of tax shield: $41.80 million / $39.81 million / $66.35 million / $38.32 million
4. Unlevered value of operations: $64.28 million / $233.62 million / $235.75 million / $228.61 million
5. Value of tax shield: $35.94 million / $74.66 million / $62.57 million / $39.65 million
6. Value of operations: $138.94 million / $271.69 million / $268.26 million / $296.19 million
7. Thus, the total value of Galaxy Sun's equity is $250.89 million / $214.95 million / $43.48 million / $275.39 million
8. Supposse BTR Warehousing plans to use more debt in the first few years of theacquisition of Galaxy Sun Corp. Assuming that using more debt will not lead to an increse in bankruptcy costs for BTR Warehousing, the interest tax shields and tha value of the tax shield in the analyssis, will decrease / increase, leading to a higher / lower value of operations of the acquired firm.
9. The APV approach is considered useful for valuing acquisition targets, because the method involves finding the values of the unlevered firm and the interest tax shield separately and then summing those values. Why is it difficult to value certain types of acquisitions using the corporate valuation model?
- The acquiring firm immediately retires the target firm's old debt. Thus, the acquisition deal consists of only new debt in its capital structure.
- The acquiring firm usually assumes the debt of the target firm. Thus, old debt with different coupon rates usually becomes a part of the aquisition deal.
Quantitative Problem: Sunshine Smoothies Company (SSC) manufactures and distributes smoothies. SSC is considering the development of a new line of high-protein energy smoothies. SSC's CFO has collected the following information regarding the proposed project, which is expected to last 3 years:
The project can be operated at the company's Charleston plant, which is currently vacant.
The project will require that the company spend $4.5 million today (t = 0) to purchase additional equipment. For tax purposes the equipment will be depreciated on a straight-line basis over 5 years. Thus, the firm's annual depreciation expense is $4,500,000/5 = $900,000. The company plans to use the equipment for all 3 years of the project. At t = 3 (which is the project's last year of operation), the equipment is expected to be sold for $1,800,000 before taxes.
The project will require an increase in net operating working capital of $730,000 at t = 0. The cost of the working capital will be fully recovered at t = 3 (which is the project's last year of operation).
Expected high-protein energy smoothie sales are as follows:
| Year | Sales |
| 1 | $2,100,000 |
| 2 | 8,000,000 |
| 3 | 3,150,000 |
The project's annual operating costs (excluding depreciation) are expected to be 60% of sales.
The company's tax rate is 40%.
The company is extremely profitable; so if any losses are incurred from the high-protein energy smoothie project they can be used to partially offset taxes paid on the company's other projects. (That is, assume that if there are any tax credits related to this project they can be used in the year they occur.)
The project has a WACC = 10.0%.
What is the project's expected NPV and IRR? Round your answers to 2 decimal places. Do not round your intermediate calculations.
| NPV | $ |
| IRR | % |
Should the firm accept the project?
The firm should accept the project.The firm should not accept the project.
SSC is considering another project: the introduction of a "weight loss" smoothie. The project would require a $3.2 million investment outlay today (t = 0). The after-tax cash flows would depend on whether the weight loss smoothie is well received by consumers. There is a 40% chance that demand will be good, in which case the project will produce after-tax cash flows of $2.3 million at the end of each of the next 3 years. There is a 60% chance that demand will be poor, in which case the after-tax cash flows will be $0.49 million for 3 years. The project is riskier than the firm's other projects, so it has a WACC of 11%. The firm will know if the project is successful after receiving the cash flows the first year, and after receiving the first year's cash flows it will have the option to abandon the project. If the firm decides to abandon the project the company will not receive any cash flows after t = 1, but it will be able to sell the assets related to the project for $2.5 million after taxes at t = 1. Assuming the company has an option to abandon the project, what is the expected NPV of the project today? Round your answer to 2 decimal places. Do not round your intermediate calculations. Use the values in "millions of dollars" to ascertain the answer.
$ millions of dollars
