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Category: Business and Industry
Date Submitted: 06/05/2011 08:58 AM
Running Head: BAUR INDUSTRIES
Baur Industries
Name
Class
Professor
Strayer University
April 29, 2011
Problem 23
Berk and DeMarzo, introduces Bauer Industries as an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental free cash flow projections (in millions of dollars):
Table 1
The net present value (NPV) decision rule is the difference between the present value of a project or investment’s benefits and the present value of its costs. When making an investment decision, take the alternative with the highest NPV. Choosing this alternative is equivalent to receiving NPV in cash today (Berk & DeMarzo, 2011). The net present value of the plant to manufacture light weight trucks can be calculated by using the formula in Figure 1, where PV represents present value, FCF demonstrates futre cash flow, r equals rate and t is year discount factor.
Figure 1
PV(FCFt) = FCFt = FCFt × 1
(1 + r)t (1 + r)t
Using the information in the table in Table 1 and entering it in the formula in Figure 1, the formula would be NPV = -150 + 36 X 1/.12 (1-1/1.129 )+ 48/1.1210 = $57.3 million (Berk & DeMarzo, 2011).
Based on input from the marketing department, Bauer is uncertain about its revenue forecast. In particular, management would like to examine the sensitivity of the NPV to the revenue assumptions. If the NPV of this project if revenues are 10% higher than forecast, then the revenue would be $94.0 million (NPV = -150 + 46 X 1/.12 (1-1/1.129) + 48/1.1210 = $94.0 million) .If the NPV if revenues are 10% lower than forecast then the revenue would be $20.5 million (NPV = -150 + 26 X 1/.12 (1-1/1.129) + 48/1.1210 = $20.5 million). Figure 2 shows the comparison (Berk & DeMarzo,...