Blank Options-

1: active, passive, real

2: decrease, increase, neutralize

3: decrease, increase, neutralize

4: decrease, increase, neutralize

5: firm should accept the project

firm should not accept the project

Capital Budgeting: Estimating Cash: Cash Flow Estimation and Risk Analysis: Real Options DCF analysis doesn't always lead to proper capital budgeting decisions because capital budgeting projects are not investments like stocks and bonds. Managers can often take positive actions after the investment has been made to alter a project's cash flows. These opportunities are real options that offer the right but not the obligation to take some future action. Types of real options include abandonment, investment timing, expansion, output flexibility, and input flexibitity. The existence of options can projects' expected profitability. their calowiated NPVs, and. their riski. The obandonment option is the option to shut down a project if operating cash flows turn out to be lower than expected. To analyze the abandonment option you can draw a decision tree, which is a diagrom that lays out different branches that are the result of different decisions made or the result of different economic situations, When analyzing real options you consider the project with and without the option. The option value is calculated as the difference between the expected NPVs with and without the relevant option. (If the value of the project without the option is negative and the NPV of the project with the option is positive, then the option value is simply the calculated NPV of the option.) It is the value that is not accounted for in a traditional NPV analysis and a positive option value expands the firm's opportunities. Quantitative Problem: Sunshane Smoothies Company (SSC) manufactures and distnbutes smoothies. SSC is considering the develepment of a new line of high-protein energy smoothies. SSC's CFO has collected the following information regarding the proposed project, which is expected to last 3 years: - The project can be operated at the company's Charleston plant, which is currently vacant. - The project will require that the company spend $4.9 million today (t=0) to purchase additional equipment. For tax purposes the equipment will be depreciated on a straight-line basis over 5 years. Thus, the firm's annual depreciation expense is $4,900,000/5=$960,000. The company plans to use the equipment for all 3 years of the project. At t=3 (which is the project's last yesr of operation), the equipment is expected to be sold for 52,300,000 before taxes. - The project will require an increase in net operating working capital of 3700,000 at t=0. The cost of the working capital will be fully recovered at t 3 (which is the project's last year of operation). - Expected high-protein energy smoothie sales are as followsi Year Sales 123$2,400,0007,850,0003,500,000 - The project's annual operating costs (excludieng depreciation) are expected to be 60% of sales. - The company's tax rate is 40%. - The company is extremely profitable; so if any losses are incurred from the high-protein energy smoothie project they can be used to partielly atfict taxes paid on the company's other projects. (That is, assume that if there are any tax credits related to this project they can be used in the year they occur.] - The project has a WACC =10,0% What is the project's expected NPV and IRR? Do not round intemediate calculations. Reund the monetary value to the nearest cent and percentage value to two decimal pleces. NPV IRR Should the firm accept the project? 5SC is considening another project: the introduction of a "weight loss" smoothe. The project would require a 43.6 million investment outlay today (t =0 ). The after-tax cash flows would depend on whether the weight loss smoothie is well received by consumers. There is a 40% chance that demand will be qood, in which case the project will produce after-tax cash flows of $2.2 million at the end of each of the next 3 years. There is a 60% chance that demand will be poor, in which case the after-tax cash flows will be 50.52 million for 3 years. The project is riskier than the firm's okher projects, so it has a WacC of 11\%. The firm will know if the project is successful after receiving the cash flows the first year, and after receiving the first year's cash flows it will have the option to abandon the project. If the firm decides to abandon the project the company will not receive any cash flews after t = 1 , but it will be able to sell the ascets related to the project for $2.8 million after taxes at t=1. Assuming the company has an option to abandon the project, what is the expected NPV of the project today? Do not round intermediate calculations. Round your answer to two decimal pleces: Use the velues in "millions" to ascertain the answer. Enter your onswer in millions, For chample, an answer of $10,550,000 should be entered as 10.55