char, You forgot to adjust the market share % in your calculations. You used 25% instead of 20%.

can someone confirm please my pessimism (in millions):
1. 21
2. 15
3. 10
4. 5
5. -9
6. -3.15
7. -5.85
8. -.85

NPV = -43.94

All three of brian's answers are correct in my book.

I also have 4.3MM for A, and 74.4MM for C.  Can somebody confirm these answers so that I know that I'm doing these correctly before I try to tackle B.  Thanks

I get

A. 4.3 million

B. - 47.56 million

C. 74.4 million

Any comments? 

I don't like my answer for B.  After reading Mr. NEAS's reply about negative pre-tax profits, I am still not sure how to compute the tax.  For this homework, is it 0 or is it a refund of 0.35*(negative profit)?

[NEAS: For a single project in a large firm, negative profits offset positive profits in other projects, so negative projects get a 35% tax refund.]

What does it mean when it says that the project has an 8 year life? Does it mean that the firm is locked into all 8 years of paying the fixed cost by some contract or similar situation? Or does it mean that the $40 million investment can apply for 8 years in the best-case scenario, and the firm can abandon the project after a bad year and avoid paying either the fixed or unit costs in following years?

[NEAS: The firm expects the project to last eight years, because the equipment lasts eight years or the market for the product lasts eight years. The eight years is an estimate, of course, but firms must make estimates to evaluate profitability. This homework assignment does not involve the real option to abandon a project; it uses present values of future cash flows.]

The 'solution' gives you the cash flow for each of the eight years.  Assume that everything is constant for each year and that the fixed cost given is for one year (not a total for all years).

I'm confused about the timing for these figures.  I assume that they are all annual figures for each of the eight years.  Therefore, the fixed cost (Description 3) is annual for each of the eight years.  If so, then the depreciation (4) is 1/8 the first year, 2/8 the second year, and so forth, since a new annual fixed cost is incurred each year.  Is the "Solution Format" provided only meant to calculate the net cash flow (8) for the first year?

Alternatively, if the fixed cost is meant to cover the entire 8 year period, then is the pretax profit (5) meant to cover the 8 years?  If so, then the depreciation should equal the entire fixed cost (1/8 per year times 8 years).

 

If your pretax profit is negative, is the tax zero or is it still 35% (i.e. a tax refund)?

[NEAS: Taxes are paid on corporate income.  Suppose a firm has two projects:

Project A earns $1,000.

Project B earns -$1,000.

The corporate earnings are zero, and the tax liability is zero.  The tax liability on Project A is $350, and the tax liability on Project B is -$350.

If a firm has negative income in total, it has a tax carryback to recover taxes paid in the past two years.  If its negative income exceeds taxes paid in the past two years, it can carry forward the operating loss for the next five years.

The tax laws are complex; they are not needed for this course.  Assume that negative income in a project leads to a tax refund.]