The Italian firm Montana SpA is attempting to choose between two proposals for new products. Both projects
Question:
The Italian firm Montana SpA is attempting to choose between two proposals for new products. Both projects will provide additional cash flows over four years and will initially cost €10,000. The cash flows from the proposals are as follows:
Year New Product A (€) New Product B (€)
1 0 4,000 2 0 4,000 3 0 4,000 4 20,000 4,000 Total 20,000 16,000 At first, it appears that Product A is better because it earns more money. However, the cash flows from Project B come earlier than those of A. Without more information, we cannot decide which set of cash flows would create the most value for the bondholders and shareholders. It depends on whether the benefit of getting cash from B up front outweighs the total extra cash from A. Bond and share prices reflect this preference for earlier cash, and we will see how to use them to decide between A and B.
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