Reference no: EM132745763

Question - a. You are the CFO of grocery chain that has constant free cash flow (FCF) of $1,000,000 per year. You currently are considering engaging in a price war with a competitor grocery firm. The price war will cause your firm's cash flows to drop to $800,000 next year (cash flows realized one year from today), and as the price war intensifies, to $650,000 the following year (two years from today). Thereafter, you expect to have knocked out your competitor - think Airbus's attempt to knock out Boeing - and afterward, to receive a permanent 5% bump in cash flows, relative to today, starting three years from now (t=3) and beyond forever. If your firm uses a discount rate of 10% for all of its activities, determine whether the price war makes sense, or not. Please explain and show how to solve in Excel.

b. Your CEO doesn't think a price war is a good idea. Rather, she wants to raise prices. This will have the opposite impact on your cash flows, relative to a cutting them. Specifically, you will make more money in the short run, but as customers eventually migrate to cheaper competitors, your long run cash flows will suffer as you lose market share. If you raise prices, cash flows over the next two years will be $1,250,000 (both at the end of t=1 and t=2), but will drop permanently to $950,000 in year t=3 and afterward. Using a discount rate of 10%, what is the NPV of the CEO's proposed price-raising project? Please explain and show how to solve in Excel.

c. Given your answers to (a) and (b), what should you do?