# Chapter 11_Solutions_14thEdition.doc - Chapter11...

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Chapter 11Capital Budgeting and RiskCHAPTER 11CAPITAL BUDGETING AND RISKSOLUTIONS TO PROBLEMS:1.a.Expected annual cash flow =.1(\$1,000) + .2(\$1,500)+ .4(\$2,000) + .2(\$2,500) + .1(\$3,000) =\$2,000b.Standard deviation =[.1(\$1,000-\$2,000)2+ .2(\$1,500-\$2,000)2+ .4(\$2,000 - \$2,000)2+ .2(\$2,500-\$2,000)2+ .1(\$3,000-\$2,000)2].5=\$547.72c.Coefficient of variation =v= \$547.72/\$2,000 =0.2742.a.z = (\$0 - \$400,000)/\$250,000 = -1.60From Table V, P (z < -1.6) =5.48%The probability of the project having negative annual net cash flowsis 5.48%.b.z = (\$575,000 - \$400,000)/\$250,000 = 0.70From Table V, P (z > 0.70) =24.20%The probability of the project having annual net cash flows in excessof\$575,000 is 24.2%.3.z = (\$0 - \$100,000) / \$50,000 = - 2.0P(z < - 2.0) = 0.0228, or2.28%from Table V11-1Internal
Chapter 11Capital Budgeting and Risk4.a.Project A is riskier using the standard deviation criterion becauseit has a larger standard deviation than B.b.Coefficient of variation calculation:vA= \$20,000/\$50,000 =0.4;vB= \$7,000/\$10,000 =0.7B is riskier using the coefficient of variation criterion.c. Because the projects are significantly different in size, thecoefficient of variation criterion, a measure of relative risk,is more appropriate.5.If reducing the variability of the firm's earnings is the desired objective,purchasing the supermarket chain is probably best.To reach thisconclusion, it was necessary to assume that the correlation of returnsbetween the supermarket chain and the steel firm as a whole is less thanthe correlation of returns between the new continuous caster and the steelfirm as a whole.This seems to be a reasonable assumption.6.a.ke= 8.0% + 1.5 (14% - 8%) =17.0%b.ke= 8.0% + 2.0(14% - 8%) =20.0%7.a.ßu= 1.5/[1 + (1 - 0.4)(.333/.667)] = 1.15ßl= 1.15[1 + (1 - 0.4)(10/90)] = 1.23ke= 4% + 1.23(11% - 4%) =12.6%b.ßu= 1.6/[1 + (1 - 0.35)(.20/.80)] = 1.38ßl= 1.38[1 + (1 - 0.4)(10/90)] = 1.4711-2Internal
Chapter 11Capital Budgeting and Riskke= 4% + 1.47(11% - 4%) =14.3%8.Payback:Project A = 3 years;Project B = 4 yearsProject B is unacceptable because its payback period is too long.Net present value:NPVA= -\$50,000 + \$20,000(.909) + \$20,000(.826)+ \$10,000(.751) + \$5,000(.683) + \$5,000(.621)=-\$1,270Project A is unacceptable because it fails to meet the NPVrequirement.Therefore, neitherproject should be undertaken by the company.9.a.NPV = -\$1,800,000 + \$400,000( (PVIFA.15,20)NPV= -\$1,800,000 + \$400,000(6.259) =\$703,600 @15%cost of capitalb.NPV @ 24% =-\$1,800,000 + \$400,000(4.110) =-\$156,00010.Net investment calculation:Equipment cost\$200,000Plus:Net working capital increase40,000Equals:Net investment\$240,000Depreciation = \$200,000/10 years = \$20,000/yearNet cash flow calculation:NCF1-5= (\$200,000 - \$90,000 - \$20,000)(1 - 0.4) + \$20,00011-3Internal
Chapter 11Capital Budgeting and RiskNCF1-5= \$74,000NCF6-9= (\$210,000 - \$105,000 - \$20,000)(1 - .4) + \$20,000NCF6-9= \$71,000NCF10

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