Unformatted text preview: s for the NPVs for each project.
Include the range of NPVs for each project.
c. Do parts a and b provide consistent views of the two projects? Explain.
d. Which project do you recommend? Why?
LG2 10–5 Sensitivity analysis James Secretarial Services is considering the purchase of
one of two new personal computers, P and Q. Both are expected to provide benefits over a 10-year period, and each has a required investment of $3,000. The
firm uses a 10% cost of capital. Management has constructed the following CHAPTER 10 Risk and Refinements in Capital Budgeting 455 table of estimates of annual cash inflows for pessimistic, most likely, and optimistic results.
Initial investment (CF0)
Outcome Computer Q $3,000 $3,000 Annual cash inflows (CF) Pessimistic $ 500 Most likely 750 750 1,000 1,200 Optimistic $ 400 a. Determine the range of annual cash inflows for each of the two computers.
b. Construct a table similar to this for the NPVs associated with each outcome
for both computers.
c. Find the range of NPVs, and subjectively compare the risks associated with
purchasing these computers.
LG2 10–6 Simulation Ogden Corporation has compiled the following information on a
capital expenditure proposal:
(1) The projected cash inflows are normally distributed with a mean of $36,000
and a standard deviation of $9,000.
(2) The projected cash outflows are normally distributed with a mean of
$30,000 and a standard deviation of $6,000.
(3) The firm has an 11% cost of capital.
(4) The probability distributions of cash inflows and cash outflows are not
expected to change over the project’s 10-year life.
a. Describe how the foregoing data can be used to develop a simulation model
for finding the net present value of the project.
b. Discuss the advantages of using a simulation to evaluate the proposed
project. LG4 10–7 Risk-adjusted discount rates—Basic Country Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firm’s cost of
capital, k, is 15%, a...
View Full Document