1. Several years ago, HomeNet purchased a
warehouse for $2,000,000 that is currently sitting empty. HomeNet estimates that the warehouse could be
sold today for $1,500,000. Alternatively,
HomeNet is considering building a new manufacturing facility next to the
warehouse and would use the warehouse to store product until it is
shipped. HomeNet’s marginal tax rate is
35%. How should HomeNet factor the empty
warehouse into its decision of whether or not to build the manufacturing facility?
a. The decision to build the manufacturing
facility is independent of the decision of what to do with the warehouse. As a result, the warehouse has no impact on
the decision about whether to build the manufacturing facility.
b. – 1,500,000
d. –(1,500,000 – (1,500,000 –
e. +(1,500,000 – (1,500,000 –
f. – 1,500,000(1-.35)
2. Pisa Pizza, a seller of frozen pizza, is
considering introducing a healthier version of its pizza that will be low in
cholesterol and contain no trans fats.
The firm expects that sales of the new pizza will be $50 million per
year. While many of these new sales will
be to new customers, Pisa Pizza estimates that 30% will come from customers who
switch to the new, healthier pizza instead of buying the original version. Suppose that 60% of the customers who will
switch from Pisa Pizza’s original pizza to its healthier pizza will switch to
another brand if Pisa Pizza does not introduce a healthier pizza. What level of incremental sales is associated
with introducing the new pizza in this case?
b. 50 – 50(.3)
d. 50 – 50(.3)(1-.6)
e. 50 – 50(1-.6)
3. Your firm would like to evaluate a
proposed new operating division. You
have forecasted cash flows for this division for the next four years and have
estimated that the cost of capital is 11%.
You would like to estimate a continuation value. You have made the following forecasts for the
last year of your four-year forecasting horizon (in millions of dollars). You have forecast that revenues, operating
income, net income, and future free cash flows after year 4 will grow at 3% per
year, forever. Estimate the continuation
value (in millions of dollars) in year 4.
Operating income 200
Net income 100
Free cash flow 220
Book value of equity 800