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Discounted Cash Flow Analysis

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A sports nutrition company is examining whether a new high-performance sports drink should be added to its product line. A preliminary feasibility analysis indicated that the company would need to invest $17.5 million in a new manufacturing facility to produce and package the product. A financial analysis using sales and cost data supplied by marketing and production personnel indicated that the net cash flow (cash inflows minus cash outflows) would be $6.1 million in the first year of commercialization, $7.4 million in year two, $7.0 million in year three, and 5.5 million in year 4.

Senior company executives were undecided whether to move forward with the development of the new product. They requested that a discounted cash flow analysis be performed using two discount rates: 20 percent and 15 percent.

a. Should the company proceed with the development of the product if the discount rate is 20 percent? Why?

b. Should the company proceed with the development of the product if the discount rate is 15 percent? Why?

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Finance Terms

Match the following finance terms with the solutions below. If none fit, indicate it.

A. The examination of differences among revenue, costs and cash flows under alternative courses of action.
B. A cost incurred in the past that cannot be changed as a result of future actions.
C. The process of planning and evaluating proposals for investments in plant assets.
D. The average annual net income from an investment expressed as a percentage of the average amount invested.
E. The length of time necessary to recover the entire cost of an investment from resulting annual net cash flows.
F. The present value of investments expected future cash flows.
G. The amount of money today that is considered equivalent to the cash flows expected to take place in the future.
H. The required rate of return used by an investor to discount future cash flows to their present value.
I. Often an investments final cash flows to be considered in discounted cash flow analysis.

NET PRESENT VALUE, DISCOUNT RATE, SUNK COST, CAPITAL BUDGET AUDIT, CAPITAL BUDGETING, PAYBACK PERIOD, SALVAGE VALUE, INCREMENTAL ANALYSIS, PRESENT VALUE, RETURN ON AVERAGE INVESTMENT

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