FINA 2201 Chapter Notes - Chapter 13: Preferred Stock, Retained Earnings, Marginal Cost

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periwinkledinosaur391

23 Mar 2016

School

Northeastern University

Department

Finance & Insurance

Course

FINA 2201

Professor

Mazur Jack

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Intro to real options passive investments once the investment has been made, most investors have no influence over the cash flows that result. 13-2 growth (expansion) options option value, which is the additional value of the project if the option exists. Value of option=expected npv with option-expected npv without option. If the expected npv without the option had been negative but the expected. Npv with the option was positive, the value of the option simply would have been the expected npv with the option. This is the value of the option because without it, the project would have been rejected and there would have been no positive npv. If the firm"s project has an abandonment option that allows the project to be stopped before the end of its physical life, this can increase expected profitability and lower risk. Value of the option=expected npv with the abandonment option-expected.

Related Questions

Martin Development Co. is deciding whether to proceed with Project X. The cost would be $11 million in Year 0. There is a 50% chance that X would be hugely successful and would generate annual after-tax cash flows of $7 million per year during Years 1, 2, and 3. However, there is a 50% chance that X would be less successful and would generate only $1 million per year for the 3 years. If Project X is hugely successful, it would open the door to another investment, Project Y, which would require an outlay of $13 million at the end of Year 2. Project Y would then be sold to another company at a price of $26 million at the end of Year 3. Martinâs WACC is 14%.

a)If the company does not consider real options, what is Project Xâs expected NPV?

b)What is Xâs expected NPV with the growth option?

c)What is the value of the growth option?

blushcattle521

**SHOW YOUR WORK**

The San Francisco Yacht Company (SFYC), a prominent sailboat builder in San Francisco, is considering developing and marketing a new line of personal sailboards whose design would be based on the âwinged keelâ technology it developed for use in its 12-meter Americas Cup racing yachts. The new sailboard line would be positioned for the upscale personal recreation market.

The project requires an initial investment of $20 million for development and production costs. The success of the project depends highly on whether its sister-product, the 12-meter racing yacht, is successful in its Americas Cup bid. If the racing yacht is successful and wins the Americas Cup (30% probability) then the positive press for the company will boost demand for the sailboard line, and annual cash after-tax cash flows will be $15 million per year for 3 years. If the yacht is successful, but does not win the Americas cup (40% probability) then after-tax cash flows will be $8 million per year for 3 years. If the yacht performs badly (30% probability) then the after-tax cash flows will be only $1 million per year for 3 years. SFYCâs cost of capital is 10%.

a What is the expected NPV of the project?

b Because SFYC owns the winged keel patent, it can wait until after the Americas Cup results are known (one year from now) before undertaking the sailboard project. If it waits, the initial investment will be the same, and SFYC will know which series of cash flows it will receive. The advantage of waiting is that SFYC will know if the bad state of the world, in which the yacht performed badly, has occurred and can choose not to invest if that occurs. Use a decision tree analysis to find the expected net present value of this investment timing decision assuming SFYC delays adopting the project, and only adopts it in the states of the world where the outcome is favorable - that is, it only adopts the project if the NPV of the branch is positive. Assume that the initial investment in Year 1, if the project is undertaken, is known with certainty and is discounted at the risk free rate of 6%, and the project will still last for 3 years (i.e. until Year 4).

c Instead of using a decision tree analysis, use the Black-Scholes Option Pricing Model to analyze this investment timing option. Assume the variance of the projectâs returns is Ï² = 0.45. Hint: One of the inputs to the model is P, the value of the asset underlying the project. Remember that P is the expected present value of the projectâs cash flows when you include both the good cash flows and the bad cash flows, but donât include the initial investment.

orchideel360

1. Consider Coral Bay Hospital. Which has a greater impact on the NPV - 10% decrease in procedures, 10% decrease in average revenue per procedure, or 10% decrease in salvage value? 10% decrease in procedures

10% decrease in average revenue

10% decrease in salvage value

2. Consider Coral Bay Hospital. A higher payback period indicates a project with lots of liquidity. True False

3. Consider Coral Bay Hospital. If the cost of capital changes to 8%, the project is a/an accept reject Consider Coral Bay Hospital. If we think inflation will be greater than 3%, we should change the cost of capital before doing the inflation sensitivity chart. True False

4. Consider Coral Bay Hospital. If the landâs value changes to $250,000, the projectâs NPV True/False

5. Consider Coral Bay Hospital. In the worst case scenario, the NPV is still positive. True False

6. Consider National Rehab Centers. A negative of doing projects in stages is that it can signal to competitors opportunities. True False

7. Consider National Rehab Centers. The inclusion of an abandonment option lowers the coefficient of variation. True False

8. Consider National Rehab Centers. If the initial fixed cost amount changed to $30,000,000, the NPV of the poor scenario will

a. increase and make project B more desirable

b. increase and make project B less desirable

c. decrease and make project B more desirable

d. decrease and make project B less desirable

9. Consider National Rehab Centers. During stage 1, if the chance for a good scenario changed to 30%, stage 1 as a stand alone project is an accept. True False

10. Consider National Rehab Centers. A good stage 1 and high demand in stage two results in a positive NPV. True False

11. Consider Southeastern Homecare. One uses the Hamada equation to see what the beta and cost of equity are under different debt ratio scenarios. True False

12. Consider Southeastern Homecare. If its dividend payout rate changed to 60%, the growth rate would ___ and the cost of equity would ____.

a. increase; increase

b. increase; decrease

c. decrease; increase

d. decrease; decrease

13.Consider Bedford Clinics. The multiple for net patient revenue is about 3. True/False

14. Consider Bedford Clinics. The revenue multiplier approach using historical revenue is good if there is lots of variability in revenues over the years. True False

15. You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5, $3,000 per year for Years 6-8, and $2,000 per year for Years 9 and 10. If you require a 14%, and the cash flows occur at the end of each year, what is the internal rate of return if the initial outlay is $10,000 and the cash flows are reinvested at the required rate of return?

a. 14%

b. 23%

c. 28%

d. 46%

16. Macy Pharmacy has a project which has the following cash flows. Year 0 = -$200,000 Year 1 = $50,000 Year 2 = $100,000 Year 3 = $150,000 Year 4 = $40,000 Year 5 = $25,000 The cost of capital is 10%. What would happen to the discounted payback if the cost of capital increased to 12%?

a. the discounted payback would increase

b. the discounted payback would decrease

c. the discounted payback would be unchanged

17. A company has determined that its optimal capital structure consists of 40% debt and 60% equity. Given the following information, calculate the firm's weighted average cost of capital. Before-tax cost of debt = 6% Tax rate = 40% Current price = $25 Growth rate = 0% Current dividend (D0) = $2.00

a. 6.0%

b. 6.2%

c. 7.0%

d. 7.2%

e. 8.0%

CORAL BAY:

FINA 2201 Chapter Notes - Chapter 13: Preferred Stock, Retained Earnings, Marginal Cost

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