state specificcaly what assumptions are being made and justify the assumptions

state specifically what assumptions are being made and justify assumptions

b. Sam Ledford, Lincoln's president and largest stockholder, is willing to make the mistake of not doing worthwhile projects as long as he avoids undertak- ing projects that he shouldn't. Is this likely to be a value-maximizing ap- proach to capital budgeting decisions? Explain. 30 Do you recommend spending the $125,000 (after taxes) on market testing and perfecting the new cleat? Defend your position SOFTWARE QUESTION 8. A number of executives have convinced Sam Ledford, the company's presi- dent, that his forecasts tend to be too conservative for "big ticket items." He also realizes that the original estimates did not consider inflation. Ledford decides to analyze the "spike project" in three different scenarios in order to get an idea of the variability of the NPV. In conjunction with two other managers, Ledford has developed the follow- ing scenarios. Pessimistic Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 90 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.3 times the estimates shown in Exhibit 1. 3. The probability is .60 that the market tests will be successful. 4. Cost of goods sold at 66 of dollar sales in Full Production, 68 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 2 percent per year. The appropriate discount rate is 20 percent. Best-Guess (Most-Likely) Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 1.1 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.2 times the estimates shown in Exhibit 1. 3. The probability is .75 that the market tests will be successful. 4. Cost of goods sold at .64 of dollar sales in Full Production, .66 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 4 percent per year. 6. The appropriate discount rate is 15 percent. Optimistic Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 1.2 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.1 times the estimates shown in Exhibit 1. & 3. The probability is .80 that the market tests will be successful. 4. Cost of goods sold at 64 of dollar sales in Full Prodction, 66 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 6 percent per year. 6. The appropriate discount rate is 15 percent. NOTE: For all scenarios the after-tax cost of the market test ("testing costs") is $125(000), the average collection period (ACP) is 35.9, inventory is 15 percent of sales, the incremental fixed-asset costs (P&E) is $800(000) with Full Production and $390(000) for Limited Production, and the after-tax terminal value of the fixed assets is 30 percent of their "up-front" cost. (a) Perform the appropriate analysis. Based on your results, what do you rec ommend? Defend your recommendation. (b) It is now 1997, that is, you are in year (t+1). The company decided to per- form the market tests which, unfortunately, were not successful. Do you recommend Limited production given the test results? Use the ap- propriate spreadsheet outputs from each scenario to form your recommen- dation. EXHIBIT 1 Annual Projections on the Existing Cleat: Unit sales Unit selling price Dollar sales Cost of goods sold Administrative costs Marketing Miscellaneous fixed (cash) Depreciation After-tax cash flow t+1 tot +7 1997-2003 13,000 $20 $260,000 $182,000 $30,000 $5,000 $15,000 Negligible $16.800 Year 1998 (t+2) 1999 2000-2003 EXHIBIT 2 Annual Unit Sales Estimates for Each Scenario Scenario Assumes the existing spike is discontinued. Limited Production Administrative Marketing Miscellaneous fixed (cash) EXHIBIT 3 Selected Cost Estimates for Each Scenario Administrative Marketing Miscellaneous fixed (cash 20,000 25,000 30,000 2+2 1998 $156,800 $137,200 $70,600 2+2 $ 84,000 $30,000 $39,200 Full Production 1+3 1999 $179,200 $112.000 $78,400 Full Production 70,000 80,000 110,000 Limited Production (+3 $105,000 $ 30,000 $ 49,000 1+42+7 2000-2003 $246,400 $77,000 $80,100 1+4 10 +7 $100,800 $25,000 $50,400 b. Sam Ledford, Lincoln's president and largest stockholder, is willing to make the mistake of not doing worthwhile projects as long as he avoids undertak- ing projects that he shouldn't. Is this likely to be a value-maximizing ap- proach to capital budgeting decisions? Explain. Do you recommend spending the $125,000 (after taxes) on market testing and perfecting the new cleat? Defend your position SOFTWARE QUESTION 8. A number of executives have convinced Sam Ledford, the company's presi- dent, that his forecasts tend to be too conservative for "big ticket items." He also realizes that the original estimates did not consider inflation. Ledford decides to analyze the "spike project" in three different scenarios in order to get an idea of the variability of the NPV. In conjunction with two other managers, Ledford has developed the follow- ing scenarios. Pessimistic Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 90 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.3 times the estimates shown in Exhibit 1. 3. The probability is .60 that the market tests will be successful. 4. Cost of goods sold at .66 of dollar sales in Full Production, .68 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 2 percent per year. The appropriate discount rate is 20 percent. Best-Guess (Most-Likely) Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 1.1 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.2 times the estimates shown in Exhibit 1. 3. The probability is 75 that the market tests will be successful. 4. Cost of goods sold at .64 of dollar sales in Full Production, .66 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 4 percent per year. 6. The appropriate discount rate is 15 percent. b. Sam Ledford, Lincoln's president and largest stockholder, is willing to make the mistake of not doing worthwhile projects as long as he avoids undertak- ing projects that he shouldn't. Is this likely to be a value-maximizing ap- proach to capital budgeting decisions? Explain. 30 Do you recommend spending the $125,000 (after taxes) on market testing and perfecting the new cleat? Defend your position SOFTWARE QUESTION 8. A number of executives have convinced Sam Ledford, the company's presi- dent, that his forecasts tend to be too conservative for "big ticket items." He also realizes that the original estimates did not consider inflation. Ledford decides to analyze the "spike project" in three different scenarios in order to get an idea of the variability of the NPV. In conjunction with two other managers, Ledford has developed the follow- ing scenarios. Pessimistic Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 90 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.3 times the estimates shown in Exhibit 1. 3. The probability is .60 that the market tests will be successful. 4. Cost of goods sold at 66 of dollar sales in Full Production, 68 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 2 percent per year. The appropriate discount rate is 20 percent. Best-Guess (Most-Likely) Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 1.1 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.2 times the estimates shown in Exhibit 1. 3. The probability is .75 that the market tests will be successful. 4. Cost of goods sold at .64 of dollar sales in Full Production, .66 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 4 percent per year. 6. The appropriate discount rate is 15 percent. Optimistic Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 1.2 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.1 times the estimates shown in Exhibit 1. & 3. The probability is .80 that the market tests will be successful. 4. Cost of goods sold at 64 of dollar sales in Full Prodction, 66 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 6 percent per year. 6. The appropriate discount rate is 15 percent. NOTE: For all scenarios the after-tax cost of the market test ("testing costs") is $125(000), the average collection period (ACP) is 35.9, inventory is 15 percent of sales, the incremental fixed-asset costs (P&E) is $800(000) with Full Production and $390(000) for Limited Production, and the after-tax terminal value of the fixed assets is 30 percent of their "up-front" cost. (a) Perform the appropriate analysis. Based on your results, what do you rec ommend? Defend your recommendation. (b) It is now 1997, that is, you are in year (t+1). The company decided to per- form the market tests which, unfortunately, were not successful. Do you recommend Limited production given the test results? Use the ap- propriate spreadsheet outputs from each scenario to form your recommen- dation. EXHIBIT 1 Annual Projections on the Existing Cleat: Unit sales Unit selling price Dollar sales Cost of goods sold Administrative costs Marketing Miscellaneous fixed (cash) Depreciation After-tax cash flow t+1 tot +7 1997-2003 13,000 $20 $260,000 $182,000 $30,000 $5,000 $15,000 Negligible $16.800 Year 1998 (t+2) 1999 2000-2003 EXHIBIT 2 Annual Unit Sales Estimates for Each Scenario Scenario Assumes the existing spike is discontinued. Limited Production Administrative Marketing Miscellaneous fixed (cash) EXHIBIT 3 Selected Cost Estimates for Each Scenario Administrative Marketing Miscellaneous fixed (cash 20,000 25,000 30,000 2+2 1998 $156,800 $137,200 $70,600 2+2 $ 84,000 $30,000 $39,200 Full Production 1+3 1999 $179,200 $112.000 $78,400 Full Production 70,000 80,000 110,000 Limited Production (+3 $105,000 $ 30,000 $ 49,000 1+42+7 2000-2003 $246,400 $77,000 $80,100 1+4 10 +7 $100,800 $25,000 $50,400 b. Sam Ledford, Lincoln's president and largest stockholder, is willing to make the mistake of not doing worthwhile projects as long as he avoids undertak- ing projects that he shouldn't. Is this likely to be a value-maximizing ap- proach to capital budgeting decisions? Explain. Do you recommend spending the $125,000 (after taxes) on market testing and perfecting the new cleat? Defend your position SOFTWARE QUESTION 8. A number of executives have convinced Sam Ledford, the company's presi- dent, that his forecasts tend to be too conservative for "big ticket items." He also realizes that the original estimates did not consider inflation. Ledford decides to analyze the "spike project" in three different scenarios in order to get an idea of the variability of the NPV. In conjunction with two other managers, Ledford has developed the follow- ing scenarios. Pessimistic Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 90 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.3 times the estimates shown in Exhibit 1. 3. The probability is .60 that the market tests will be successful. 4. Cost of goods sold at .66 of dollar sales in Full Production, .68 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 2 percent per year. The appropriate discount rate is 20 percent. Best-Guess (Most-Likely) Scenario 1. Unit sales for the Full Production and Limited Production scenarios at 1.1 of the original estimates shown in Exhibit 2. 2. Unit sales of the old cleat at 1.2 times the estimates shown in Exhibit 1. 3. The probability is 75 that the market tests will be successful. 4. Cost of goods sold at .64 of dollar sales in Full Production, .66 for Limited Production, and .70 for the old cleat. 5. The selling price of the new cleat will be $28, increasing at 4 percent per year. 6. The appropriate discount rate is 15 percent