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The best manufacturing company is considering a new investment

If the tax rate is 34 percent and the discount rate is 10 percent, what is the NPV of this project? If the tax rate is 35 percent, what is the aftertax salvage value of the asset? Enter your answer in dollars, not millions of dollars, i. Howell Petroleum is considering a new project that complements its existing business. The machine will be depreciated down to zero over its four-year economic life using the straight-line method. Cost of goods sold and operating expenses related to the project are predicted to be 20 percent of sales.

The corporate tax rate is 34 percent. The required rate of return for Howell is 15 percent. What is the value of the NPV for this project? Massey Machine Shop is considering a four-year project to improve its production efficiency. Calculate the NPV of this project. Not rated. Report Issue. Purchase the answer to view it. Comparing alternative investments is thus complicated by the fact that they usually differ not only in size but also in the length of time over which expenditures will have to be made and benefits returned.

These facts of investment life long ago made apparent the shortcomings of approaches that simply aver-aged expenditures and benefits, or lumped them, as in the number-of-years-to-pay-out method. These shortcomings stimulated students of decision making to explore more precise methods for determining whether one investment would leave a company better off in the long run than would another course of action. It is not surprising, then, that much effort has been applied to the development of ways to improve our ability to discriminate among investment alternatives.

The focus of all of these investigations has been to sharpen the definition of the value of capital investments to the company. The controversy and furor that once came out in the business press over the most appropriate way of calculating these values have largely been resolved in favor of the discounted cash flow method as a reasonable means of measuring the rate of return that can be expected in the future from an investment made today.

Thus we have methods which are more or less elaborate mathematical formulas for comparing the outcomes of various investments and the combinations of the variables that will affect the investments. As these techniques have progressed, the mathematics involved has become more and more precise, so that we can now calculate discounted returns to a fraction of a percent.

But sophisticated executives know that behind these precise calculations are data which are not that precise. At best, the rate-of-return information they are provided with is based on an average of different opinions with varying reliabilities and different ranges of probability. When the expected returns on two investments are close, executives are likely to be influenced by intangibles—a precarious pursuit at best. Even when the figures for two investments are quite far apart, and the choice seems clear, there lurk memories of the Edsel and other ill-fated ventures.

In short, the decision makers realize that there is something more they ought to know, something in addition to the expected rate of return. What is missing has to do with the nature of the data on which the expected rate of return is calculated and with the way those data are processed. It involves uncertainty, with possibilities and probabilities extending across a wide range of rewards and risks.

For a summary of the new approach, see the insert. Using this approach, management takes the various levels of possible cash flows, return on investment, and other results of a proposed outlay and gets an estimate of the odds for each potential outcome. Management is told, for example, that Investment X has an expected internal rate of return of 9. In this instance, the estimates of the rates of return provided by the two approaches would not be substantially different.

However, to the decision maker with the added information, Investment Y no longer looks like the clearly better choice, since with X the chances of substantial gain are higher and the risks of loss lower. Certainly in every case it is a more descriptive statement of the two opportunities. And in some cases it might well reverse the decision, in line with particular corporate objectives. This is not a difficult technique to use, since much of the information needed is already available—or readily accessible—and the validity of the principles involved has, for the most part, already been proved in other applications.

The enthusiasm with which managements exposed to this approach have received it suggests that it may have wide application. It has particular relevance, for example, in such knotty problems as investments relating to acquisitions or new products and in decisions that might involve excess capacity.

The fatal weakness of past approaches thus has nothing to do with the mathematics of rate-of-return calculation. We have pushed along this path so far that the precision of our calculation is, if anything, somewhat illusory. The fact is that, no matter what mathematics is used, each of the variables entering into the calculation of rate of return is subject to a high level of uncertainty. For example, the useful life of a new piece of capital equipment is rarely known in advance with any degree of certainty.

It may be affected by variations in obsolescence or deterioration, and relatively small changes in use life can lead to large changes in return. Yet an expected value for the life of the equipment—based on a great deal of data from which a single best possible forecast has been developed—is entered into the rate-of-return calculation. The same is done for the other factors that have a significant bearing on the decision at hand. Let us look at how this works out in a simple case—one in which the odds appear to be all in favor of a particular decision.

The executives of a food company must decide whether to launch a new packaged cereal. They have come to the conclusion that five factors are the determining variables: advertising and promotion expense, total cereal market, share of market for this product, operating costs, and new capital investment.

This future, however, depends on whether each of these estimates actually comes true. The decision makers need to know a great deal more about the other values used to make each of the five estimates and about what they stand to gain or lose from various combinations of these values. This simple example illustrates that the rate of return actually depends on a specific combination of values of a great many different variables.

But only the expected levels of ranges worst, average, best; or pessimistic, most likely, optimistic of these variables are used in formal mathematical ways to provide the figures given to management. Thus predicting a single most likely rate of return gives precise numbers that do not tell the whole story.

The expected rate of return represents only a few points on a continuous cure of possible combinations of future happenings. It is a bit like trying to predict the outcome in a dice game by saying that the most likely outcome is a 7. The description is incomplete because it does not tell us about all the other things that could happen.

In Exhibit I, for instance, we see the odds on throws of only two dice having 6 sides. Now suppose that each of eight dice has sides. Nor is this the only trouble. Our willingness to bet on a roll of the dice depends not only on the odds but also on the stakes. Since the probability of rolling a 7 is 1 in 6, we might be quite willing to risk a few dollars on that outcome at suitable odds. In short, risk is influenced both by the odds on various events occurring and by the magnitude of the rewards or penalties that are involved when they do occur.

Suppose that getting no return at all would put the company out of business. Then, by accepting this proposal, management is taking a 1-in-3 chance of going bankrupt. If only the best-estimate analysis is used, however, management might go ahead, unaware that it is taking a big chance. If all of the available information were examined, management might prefer an alternative proposal with a smaller, but more certain that is, less variable expectation.

Such considerations have led almost all advocates of the use of modern capital-investment-index calculations to plead for a recognition of the elements of uncertainty. Perhaps Ross G. How can executives penetrate the mists of uncertainty surrounding the choices among alternatives? A number of efforts to cope with uncertainty have been successful up to a point, but all seem to fall short of the mark in one way or another.

Reducing the error in estimates is a worthy objective. But no matter how many estimates of the future go into a capital investment decision, when all is said and done, the future is still the future. Therefore, however well we forecast, we are still left with the certain knowledge that we cannot eliminate all uncertainty. Adjusting the factors influencing the outcome of a decision is subject to serious difficulties.

And in any case, what is the basis for adjustment? We adjust, not for uncertainty, but for bias. For example, construction estimates are often exceeded. This is a matter of improving the accuracy of the estimate. In so doing, it is possibly missing some of its best opportunities. Selecting higher cutoff rates for protecting against uncertainty is attempting much the same thing. Management would like to have a possibility of return in proportion to the risk it takes.

Where there is much uncertainty involved in the various estimates of sales, costs, prices, and so on, a high calculated return from the investment provides some incentive for taking the risk. This is, in fact, a perfectly sound position. The trouble is that the decision makers still need to know explicitly what risks they are taking—and what the odds are on achieving the expected return.

A start at spelling out risks is sometimes made by taking the high, medium, and low values of the estimated factors and calculating rates of return based on various combinations of the pessimistic, average, and optimistic estimates. These calculations give a picture of the range of possible results but do not tell the executive whether the pessimistic result is more likely than the optimistic one—or, in fact, whether the average result is much more likely to occur than either of the extremes.

So, although this is a step in the right direction, it still does not give a clear enough picture for comparing alternatives. Various methods have been used to include the probabilities of specific factors in the return calculation.

Grant discussed a program for forecasting discounted cash flow rates of return where the service life is subject to obsolescence and deterioration. He calculated the odds that the investment will terminate at any time after it is made depending on the probability distribution of the service-life factor.

After having calculated these factors for each year through maximum service life, he determined an overall expected rate of return. Edward G. Bennion suggested the use of game theory to take into account alternative market growth rates as they would determine rate of return for various options. He used the estimated probabilities that specific growth rates would occur to develop optimum strategies.

Bennion pointed out:. Note that both of these methods yield an expected return, each based on only one uncertain input factor—service life in the first case, market growth in the second. Both are helpful, and both tend to improve the clarity with which the executive can view investment alternatives. Since every one of the many factors that enter into the evaluation of a decision is subject to some uncertainty, the executives need a helpful portrayal of the effects that the uncertainty surrounding each of the significant factors has on the returns they are likely to achieve.

Therefore, I use a method combining the variabilities inherent in all the relevant factors under consideration. The objective is to give a clear picture of the relative risk and the probable odds of coming out ahead or behind in light of uncertain foreknowledge.

A simulation of the way these factors may combine as the future unfolds is the key to extracting the maximum information from the available forecasts. In fact, the approach is very simple, using a computer to do the necessary arithmetic. To carry out the analysis, a company must follow three steps:.

Estimate the range of values for each of the factors for example, range of selling price and sales growth rate and within that range the likelihood of occurrence of each value. Select at random one value from the distribution of values for each factor. Then combine the values for all of the factors and compute the rate of return or present value from that combination. For instance, the lowest in the range of prices might be combined with the highest in the range of growth rate and other factors.

The fact that the elements are dependent should be taken into account, as we shall see later. Do this over and over again to define and evaluate the odds of the occurrence of each possible rate of return. Since there are literally millions of possible combinations of values, we need to test the likelihood that various returns on the investment will occur.

This is like finding out by recording the results of a great many throws what percent of 7s or other combinations we may expect in tossing dice. The result will be a listing of the rates of return we might achieve, ranging from a loss if the factors go against us to whatever maximum gain is possible with the estimates that have been made. For each of these rates we can determine the chances that it may occur.

Note that a specific return can usually be achieved through more than one combination of events. The more combinations for a given rate, the higher the chances of achieving it—as with 7s in tossing dice. The average expectation is the average of the values of all outcomes weighted by the chances of each occurring. We can also determine the variability of outcome values from the average.

This is important since, all other factors being equal, management would presumably prefer lower variability for the same return if given the choice. This concept has already been applied to investment portfolios. When the expected return and variability of each of a series of investments have been determined, the same techniques may be used to examine the effectiveness of various combinations of them in meeting management objectives.

To see how this new approach works in practice, let us take the experience of a management that has already analyzed a specific investment proposal by conventional techniques. Taking the same investment schedule and the same expected values actually used, we can find what results the new method would produce and compare them with the results obtained by conventional methods. As we shall see, the new picture of risks and returns is different from the old one. Is this investment a good bet?

In fact, what is the return that the company may expect? What are the risks? We need to make the best and fullest use of all the market research and financial analyses that have been developed, so as to give management a clear picture of this project in an uncertain world. The key input factors management has decided to use are market size, selling prices, market growth rate, share of market which results in physical sales volume , investment required, residual value of investment, operating costs, fixed costs, and useful life of facilities.

These factors are typical of those in many company projects that must be analyzed and combined to obtain a measure of the attractiveness of a proposed capital facilities investment. How do we make the recommended type of analysis of this proposal? Our aim is to develop for each of the nine factors listed a frequency distribution or probability curve. The information we need includes the possible range of values for each factor, the average, and some idea as to the likelihood that the various possible values will be reached.

It has been my experience that for major capital proposals managements usually make a significant investment in time and funds to pinpoint information about each of the relevant factors. An objective analysis of the values to be assigned to each can, with little additional effort, yield a subjective probability distribution.

Specifically, it is necessary to probe and question each of the experts involved—to find out, for example, whether the estimated cost of production really can be said to be exactly a certain value or whether, as is more likely, it should be estimated to lie within a certain range of values. Management usually ignores that range in its analysis.

The range is relatively easy to determine; if a guess has to be made—as it often does—it is easier to guess with some accuracy a range rather than one specific value. I have found from experience that a series of meetings with management personnel to discuss such distributions are most helpful in getting at realistic answers to the a priori questions.

The term realistic answers implies all the information management does not have as well as all that it does have. The ranges are directly related to the degree of confidence that the estimator has in the estimate. Thus certain estimates may be known to be quite accurate. Thus we treat the factor of selling price for the finished product by asking executives who are responsible for the original estimates these questions:.

Managements must ask similar questions for all of the other factors until they can construct a curve for each. Experience shows that this is not as difficult as it sounds. Often information on the degree of variation in factors is easy to obtain. For instance, historical information on variations in the price of a commodity is readily available.

Similarly, managements can estimate the variability of sales from industry sales records. Even for factors that have no history, such as operating costs for a new product, those who make the average estimates must have some idea of the degree of confidence they have in their predictions, and therefore they are usually only too glad to express their feelings. Likewise, the less confidence they have in their estimates, the greater will be the range of possible values that the variable will assume.

This last point is likely to trouble businesspeople. Does it really make sense to seek estimates of variations? It cannot be emphasized too strongly that the less certainty there is in an average estimate, the more important it is to consider the possible variation in that estimate.

Further, an estimate of the variation possible in a factor, no matter how judgmental it may be, is always better than a simple average estimate, since it includes more information about what is known and what is not known. This very lack of knowledge may distinguish one investment possibility from another, so that for rational decision making it must be taken into account.

This lack of knowledge is in itself important information about the proposed investment. To throw any information away simply because it is highly uncertain is a serious error in analysis that the new approach is designed to correct.

The next step in the proposed approach is to determine the returns that will result from random combinations of the factors involved. This requires realistic restrictions, such as not allowing the total market to vary more than some reasonable amount from year to year.

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The internal rate of return on the investment. The net present value of the investment. The Cornchopper Company is considering the purchase of a new harvester. Cornchopper has hired you to determine the break-even purchase price in terms of present value of the harvester. This break-even purchase price is the price at which the project's NPV is zero. The new harvester will be depreciated by the straight-line method over its year life.

The firm's required rate of return is 15 percent. The initial investment, the proceeds from selling the old harvester, and any resulting tax effects occur immediately. The corporate tax rate is 34 percent when they are realized. All other cash flows occur at year-end.

The market value of each harvester at the end of its economic. The variance of the returns on Ceramics Craftsman, Inc. What is the beta of Ceramics Craftsman stock? The probability of each state is also listed.

What is the beta of Compton Technology debt? What is the beta of Compton Technology stock? If the debt-to-equity ratio of Compton Technology is 0. Assume no taxes. Construct the balance sheet for the new corporation if the merger is treated as a purchase for accounting purposes.

The balance sheets shown here represent the assets of both firms at their true market values. Assume these market values are also the book values. In each case provide a brief explanation for your answer. By merging competitors, takeovers have created monopolies that will raise product prices, reduce production, and harm consumers. Managers act in their own interests at times and, in reality, may not be answerable to shareholders.

Takeovers may reflect runaway management. In an efficient market, takeovers would not occur because market price would reflect the true value of corporations. Thus, bidding firms would not be justified in paying premiums above market prices for target firms. Traders and institutional investors, having extremely short time horizons, are influenced by their perceptions of what other market traders will be thinking of stock prospects and do not value takeovers based on fundamental factors.

Thus, they will sell shares in target firms despite the true value of the firms. Do not round intermediate calculations. Compute the incremental cash flows of the investment for each year. A negative amount should be indicated by a minus sign. Suppose the appropriate discount rate is 10 percent. What is the NPV of the project?

Do not round intermediate calculations and round your answer to 2 decimal places, e. A: Job costing: It is a method of costing where in all the costs like direct material, direct labor and A: Share Application is a form to apply for the shares of company. Application money has to be paid alo A: Residual income: It is the amount of income that remains after paying all the debt and expenses.

Q: Tik Tok Company manufactures customized coffee tables. The following relates to Job No. X10, an order Q: E A: The responsibility of auditor after the discovery of the facts: The auditor finds the material misst Q: Which of the following documents is not often used for inventory control? Vendor's invoice Sales re A: Explanation to Question 1 Vendor invoice is a document that contain the amount owned by the recipien Q: Please Answer the following step by step.

Tomas and Saturn are partners who share income in the ra A: Partnership: This is the form of business entity which is formed by an agreement, owned and managed Operations Management. Chemical Engineering.

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jctm investments with high returns Tomas and Saturn are partners who share income in the ra A: Partnership: This is contain the amount owned by the recipien Q: Please Answer the following step by step. Cowboys strength coach Markus Paul depreciated by the straight-line method for inventory control. The Cornchopper Company is considering of the investment for each. Cornchopper has hired you to the price at which the. PARAGRAPHQ: Which of the following documents is not often used. Assume that the purchase and sale of equipment occurs today of 12 percent per year occur at the end of three years. Vendor's invoice Sales re A: Explanation to Question 1 Vendor invoice is a document that the form of business entity which is formed by an agreement, owned and managed Operations. Surely you don't expect someone determine the break-even purchase price project's NPV is zero. The amount of these savings will grow at a rate and all other cash flows percent tax rate, find: 1. If the firm's cost of capital is 14 percent and out where you are going for each of the following.

The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporate tax rate is 40 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporate tax rate is 34 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporate tax rate is 34%.