6 note that the 10 radr for project b using the risk

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Unformatted text preview: ojects being compared are ongoing. If they were not, the project with the highest NPV would be selected. 6. Note that the 10% RADR for project B using the risk classes in Table 10.3 differs from the 11% RADR used in the preceding example for project B. This difference is attributable to the less precise nature of the use of risk classes. 442 PART 3 Long-Term Investment Decisions The Problem A simple example will demonstrate the basic problem of noncomparability caused by the need to select the best of a group of mutually exclusive projects with differing usable lives. EXAMPLE The AT Company, a regional cable television company, is evaluating two projects, X and Y. The relevant cash flows for each project are given in the following table. The applicable cost of capital for use in evaluating these equally risky projects is 10%. Project X Initial investment Year Project Y $70,000 $85,000 Annual cash inflows 1 28000 CF1 33000 CF2 38000 I 20,000 — 15,000 6 — 10,000 Table Use The net present value of each project at the 10% cost of capital is calculated by finding the present value of each cash inflow, summing them, and subtracting the initial investment from the sum of the present values. CF3 10 25,000 — 5 Function CF0 30,000 38,000 4 Input 70000 $35,000 33,000 3 Project X $28,000 2 NPVX [$28,000 (0.909)] [$33,000 (0.826)] [$38,000 ($25,452 $27,258 $28,538) $70,000 $81,248 $70,000 $11,248 NPVY [$35,000 (0.909)] [$30,000 (0.826)] [$25,000 (0.751)] [$20,000 (0.683)] [$15,000 (0.621)] [$10,000 (0.564)] $85,000 ($31,815 $24,780 $18,775 $13,660 $9,315 $5,640) $85,000 $103,985 $85,000 $18,985 NPV Solution 11277.24 Project Y Input 85000 Function CF0 35000 CF1 30000 CF2 25000 CF4 15000 CF5 10000 CF6 10 I $70,000 CF3 20000 (0.751)] NPV Solution 19013.27 The NPV for project X is $11,248; that for project Y is $18,985. Calculator Use Employing the preprogrammed NPV function in a financial calculator, we use the keystrokes shown at the left for project X and for project Y to find t...
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This document was uploaded on 01/19/2014.

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