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IN CAPITAL BUDGETING
Options to extend
Options to switch
Abandonment/shutdown options
How to answer:
Determine the expected NPV without the opportunity to expand and the
expected NPV with the opportunity to expand.
FACTORS TO CONSIDER WHEN DECIDING ON
INVESTMENTS THAT HAVE GROWTH OPTIONS
Should the firm operate the truck until the end of its 5-year physical life; if
not, what is the trucks optimal economic life?
Would the introduction of abandonment values, in addition to operating cash
flows, ever reduce the expected NPV and/or IRR of a project? Explain.
ILLUSTRATION 6:
ABANDONMENT OPTIONS
11.39
D WACC
11.2
11.02
B
10.7
10.58 IRR
10.22
9.86
New
Capital
3,200,000 4,950,000 5,400,000 6,700,000
3,000,000 4,725,000 5,225,000 6,000,000
OPTIMAL CAPITAL BUDGET
The company has a target capital structure that consists of 40% debt
and 60% common equity. The company can issue bonds with a YTM
of 11%. The company has $600,000 in retained earnings, and the
current stock price is $42 per share. The flotation costs associated
with issuing new equity are $2 per share. Gibsons earnings are
expected to continue to grow at 6% per year. Next years dividend is
forecasted to be $4. The firm faces a 40% tax rate. What is the size
of Gibsons optimal capital budget?
QUALITATIVE ASSESSMENT OF A REAL OPTIONS
VALUE: