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a) You are considering a new product. It will cost $966,000 to launch, have a 3-year life, and no salvage value. Depreciation is straight-line to

a) You are considering a new product. It will cost $966,000 to launch, have a 3-year life, and no salvage value. Depreciation is straight-line to zero. The required return is 20%, and the tax rate is 30%. Sales are projected at 80 units per year. Price per unit will be $40,000, variable cost per unit is $24,000 and fixed costs are $500,000 per year. Operating cash flows have been calculated for you as $642,600 per year.

i) What is the base case net present value?

ii) Suppose that the sales units, price per unit, variable cost per unit, and fixed cost projections above are accurate to within 15%.

What are the new variables for the best case and worst case scenarios?

iii) What is the accounting break-even for this project?

What is the degree of operating leverage?

b) Give two examples of managerial options that need to be considered in capital budgeting decisions.

c) What is a put option? What is a call option?

d) If you are the buyer of a put option, and the underlying share price is above the exercise price, are you in the money or out of the money? explain why.

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