1. (a) What is a firm's strategic policy? How, if at all, does it influence a firm's choice of capital budgeting projects? (b) What is an "unbiased" cash flow forecast? Do you find it surprising that studies have found that the actual cash flows of "sales projects" tend to be well below the predicted amounts? Defend your answer. 2. Management uses an 11 percent required return (cost of capital) for projects of the Ball Division, 12 percent for Accessories', and 14 percent for Equipment's projects. Some of Pinnacle's plant managers feel that it is "unfair" to use three different rates. They argue that "we are all part of one firm so projects should use the same rate.' " How would you respond to this objection? The yearly cash flow estimates of the Price Increase option (see Exhibit 5a) on the equipment decision ignore any possible working capital require- ments. That is, these estimates assume that no additional working capital is necessary. Is this a reasonable assumption to make? Defend your answer. NOTE: "Working capital" is defined here as A/R + INV - A/P - Accruals. 4. Assuming a discount rate of 12 percent, the NPV of the proposal of the Accessories Division is $6,043(000) (see Exhibit 2 for the yearly cash flow estimates). Write out the equation used to determine this NPV. 5. Assuming a discount rate of 14 percent, the NPV of the Price Increase option of the Equipment Division is $4,666(000) (see Exhibit 5a for the cash flow estimates). Calculate the NPV of the Expand Option using a rate of 14 percent (See Exhibit 5b).

6. The Equipment Division really has another option, which is literally to "Do Nothing.(a) It is not necessary to do an NPV to determine that Price Increase is superior to Do Nothing. Why? (b) What, then, is the advantage of doing an NPV on Price Increase? 7. (a) Complete the table below, which shows the incremental yearly cash flows ($000s) of the Pull Old option of the Ball Division (use the As Is position as the base from which to calculate these incremental amounts). (b) Calculate the NPV of this project using a discount rate of 11 percent. Year Inc. CH +=0 1996 (4825) 1900 1998 2600 1999 2600 2001 1100 2002 2280 8. (a) Calculate the yearly incremental cash flows of the Keep Old alternative of the Ball Division using "As Is" as the base position. (b) Calculate the NPV using a discount rate of 11 percent. 9. Given the managerial and technical bottlenecks that Pinnacle faces, and its apparent desire for "orderly growth," list the firm's capital budgeting "choice set." That is, list the ball/equipment / accessories options open to management. 10. If a project's predicted NPV > 0, the implication is that the firm expects to make an economic profit from the project. (a) What are economic profits? (b) Under what circumstances, if any, can a firm expect to earn economic profits? 11. Play the role of a consultant. Based on your previous answers and other information in the case, how do you think management should proceed? Fully support your position. SOFTWARE QUESTION 12. (a) Pinnacle's top executives still think that it is prudent to do only one "major" project, though it appears that no other major projects are likelv in the foreseeable future. They have also caretully examined the estimates of each proposal and concluded that the tollowing assumptions are appropriate. Annual unit golf ball sales should remain as originally projected (see Exhibit 3). 2. The price of the old ball (the ProFlite LD) will be $1 in years 1-3, $.95 in years 4 and 5, and $.90 in vear 6.

3. The price of the new ball (the Medallion LS) will be $1.10 in year 1, $1.05 in years 2 and 3, and $1 in years 4-6. 4. Cost of goods sold will be $.60 per unit each year for the old ball and $.63 for the new ball. 5. The annual cash flow projections of Price Increase should be raised by 10 percent (see Exhibit 5a). 6. The annual cash flows of the Expand (equipment) option remain as originally projected (see Exhibit 5b). 7. The annual cash flow projections of the Accessories Division for years 1996 (t + 1) - 2001 (t + 6) should be reduced by 20 percent (see Exhibit 2). 8. The appropriate discount rates are 10 percent for Keep Old, 11 per- cent for Pull Old, 10 percent for Price Increase, 13 percent for Expand (equipment), and 11 percent for Accessories. Analyze this scenario. What do you recommend based on these results? Explain. involves removing from the market a "known product." A number of Pinnacle's managers, however, think this interest rate differential is inappropriate. They believe that the same discount rate should be used on Keep Old and Pull Old, either 10 percent or 11 percent. How does all this affect your recommendation in part (a)? Explain. (Keep all other inputs at the values in part (a).) EXHIBIT 1 Projected Unit Sales of Precision Clubs (000s)* 75 2001 t+6 2002 75 *These proiections assume no change in the current price of $600 per set. The firm is presently producing at capacity or 4U(0UU) sets per year EXHIBIT 2 Projected Yearly Incremental Sales and After-Tax Cash Flows of the Accessories Division Proiect ($000s) =0 1004 100 1+3 1000 + 5 +6 200. Incremental Sales Incremental cash flow ($12,300) $13,000 1,600 18.000 2,700 25,000 4,300 30.000 5,600 30.000 5,600 30,000 9,800

EXHIBIT Projected Unit Golf Ball Sales, Various Scenarios (Millions)# 1997 As Is Pull Old 40 Keep Old Description of Each Scenario As s Onlv the old ball. the Profite LD. is sold. The new ball. the Medallion IS. is not introduced. Pull Old Keep Uld The new ball is introduced and the old ball 1s discontinued Both the new and the old balls are produced and sold. Annual unit sales are distributed as follows: 35 (million) due to the new; 30 (million) due to the old. *These forecasts assume the old ball (ProFlite LD) sells for $1 and the new ball (Medallion LS) for $1.10 during years 1-3 and >I in years As Is Pull Old Keep Old As Is Pull Old Keep Old Pull Old Keep Old EXHIBIT 4 Selected Cost Estimates of the Ball Division ($000s) Marketing ++ ) -L +6 1997 1998 1900 2000 2001 $1,600 $4,200 $4,700 1,600 4,200 1,600 4,200 1,600 2,000 2,700 1,600 2.000 2,/Ul Administrative + 2 $4,400 $5,200 4 41 5,200 3,800 44 5,200 3,800 4 410 5,200 3,800 440 5,200 Miscelaneous Fixed (Cash) $4,000 $4,500 $5.500 4,000 4,500 5,500 4,000 4,500 5.500 4,000 4,500 5,500 4,000 4,500 1-0 1,600 2.000 3,800 5,200 4,000