Reference no: EM13201112
Cash Flows ($)
Project C0 C1 C2 C3 C4 C5 IRR (%) NPV at 10%
F -9,000 +6,000 +5000 +4000 0 0 33 3,592
G -9,000 +1,800 +1,800 +1,800 +1,800 +1,800 20 9,000
H -- -6,000 +1,200 +1,200 +1,200 +1,200 20 6,000
1. Look back to the cash flows for projects F and G. The cost of capital was assumed to be 10%. Assume that the forecasted cash flows for projects of this type are over- stated by 8% on average. That is, the forecast for each cash flow from each project should be reduced by 8%. But a lazy financial manager, unwilling to take the time to argue with the projects' sponsors, instructs them to use a discount rate of 18%.
a. What are the projects' true NPVs?
b. What are the NPVs at the 18% discount rate?
c. Are there any circumstances in which the 18% discount rate would give the correct NPVs? (Hint: Could upward bias be more severe for more-distant cash flows?)
Otobai's accounting profit:
Unit Sales Revenues Variable Fixed Depreciation Taxes Total Profit
(thousands) Years 1-10 Costs Costs Costs after Tax
0 0 0 3 1.5 -2.25 2.25 -2.25
100 37.5 30 3 1.5 1.5 36.0 1.5
200 75.0 60 3 1.5 5.25 69.75 5.25
Suppose that the expected variable costs of Otobai's project are ¥33 billion a year and that fixed costs are zero. How does this change the degree of operating leverage? Now recompute the operating leverage assuming that the entire ¥33 billion of costs are fixed.
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