Unformatted text preview: ences in risk and assuming that the firm’s cost of capital is
10%, calculate the net present value (NPV) of each project. CHAPTER 10 Risk and Refinements in Capital Budgeting 453 b. Use NPV to evaluate the projects, using risk-adjusted discount rates (RADRs)
to account for risk.
c. Compare, contrast, and explain your findings in parts a and b. PROBLEMS
LG1 10–1 Recognizing risk Caradine Corp., a media services firm with net earnings of
$3,200,000 in the last year, is considering several projects.
Project Initial Investment Details A $ 35,000 B 500,000 Purchase digital film-editing equipment for use with
several existing accounts. C 450,000 Develop proposal to bid for a $2,000,000 per year
10-year contract with the U.S. Navy, not now an
account. D 685,000 Purchase the exclusive rights to market a quality
educational television program in syndication to local
markets in the European Union, a part of the firm’s
existing business activities. Replace existing office furnishings. The media services business is cyclical and highly competitive. The board of
directors has asked you, as chief financial officer, to
a. Evaluate the risk of each proposed project and rank it “low,” “medium,” or
b. Comment on why you chose each ranking.
LG2 10–2 Breakeven cash inflows Etsitty Arts, Inc., a leading producer of fine cast silver
jewelry, is considering the purchase of new casting equipment that will allow it
to expand the product line into award plaques. The proposed initial investment
is $35,000. The company expects that the equipment will produce steady income
throughout its 12-year life.
a. If Etsitty requires a 14% return on its investment, what minimum yearly cash
inflow will be necessary for the company to go forward with this project?
b. How would the minimum yearly cash inflow change if the company required
a 10% return on its investment? LG2 10–3 Breakeven cash inflows and risk Pueblo Enterprises is considering investing in
either of two mutually exclusive projects, X and Y. Project X req...
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