Exercise of this option is estimated to add 3000 to

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Unformatted text preview: s caused the firm’s forecast revenues to develop more slowly than planned. Such a delay in implementation at that point has a NPV of $10,000. Rene estimated that there was a 25% chance that the abandonment option would need to be exercised, a 30% chance the expansion option would be exercised, and only a 10% chance that the implementation of certain phases of the project would have to be delayed. a. Use the information provided to calculate the strategic NPV, NPVstrategic, for Asor Products’ proposed equipment expenditure. b. Judging on the basis of your findings in part a, what action should Rene recommend to management with regard to the proposed equipment expenditures? c. In general, how does this problem demonstrate the importance of considering real options when making capital budgeting decisions? LG6 10–15 Capital rationing—IRR and NPV approaches Valley Corporation is attempting to select the best of a group of independent projects competing for the firm’s fixed capital budget of $4.5 million. The firm recognizes that any unused portion of this budget will earn less than its 15% cost of capital, thereby resulting in a present value of inflows that is less than the initial investment. The firm has summarized the key data to be used in selecting the best group of projects in the following table. Project Initial investment IRR Present value of inflows at 15% A $5,000,000 17% $5,400,000 B 800,000 18 1,100,000 C 2,000,000 19 2,300,000 D 1,500,000 16 1,600,000 E 800,000 22 900,000 F 2,500,000 23 3,000,000 G 1,200,000 20 1,300,000 CHAPTER 10 Risk and Refinements in Capital Budgeting 461 a. Use the internal rate of return (IRR) approach to select the best group of projects. b. Use the net present value (NPV) approach to select the best group of projects. c. Compare, contrast, and discuss your findings in parts a and b. d. Which projects should the firm implement? Why? LG6 10–16 Capital rationing—NPV approach A firm with a 13% cost of capital must select the optimal group of projects from those shown in the follow...
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This document was uploaded on 01/19/2014.

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