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Unformatted text preview: uires an initial
investment of $30,000; project Y requires $40,000. Each project’s cash inflows
are 5-year annuities; project X’s inflows are $10,000 per year; project Y’s are
$15,000. The firm has unlimited funds and, in the absence of risk differences,
accepts the project with the highest NPV. The cost of capital is 15%.
a. Find the NPV for each project. Are the projects acceptable?
b. Find the breakeven cash inflow for each project. 454 PART 3 Long-Term Investment Decisions c. The firm has estimated the probabilities of achieving various ranges of cash
inflows for the two projects, as shown in the following table. What is the
probability that each project will achieve the breakeven cash inflow found
in part b?
Probability of achieving
cash inflow in given range
Range of cash inflow
$0 to $5,000
$5,000 to $7,500 Project X
10 Project Y
10 $7,500 to $10,000 60 15 $10,000 to $12,500 25 25 $12,500 to $15,000 5 20 $15,000 to $20,000 0 15 Above $20,000 0 10 d. Which project is more risky? Which project has the potentially higher NPV?
Discuss the risk-return tradeoffs of the two projects.
e. If the firm wished to minimize losses (that is, NPV $0), which project
would you recommend? Which would you recommend if the goal, instead,
was achieving the higher NPV?
LG2 10–4 Basic sensitivity analysis Murdock Paints is in the process of evaluating two
mutually exclusive additions to its processing capacity. The firm’s financial analysts have developed pessimistic, most likely, and optimistic estimates of the
annual cash inflows associated with each project. These estimates are shown in
the following table.
Initial investment (CF0)
Outcome Project B $8,000 $8,000 Annual cash inflows (CF) Pessimistic $ 200 Most likely 1,000 $ 900
1,000 Optimistic 1,800 1,100 a. Determine the range of annual cash inflows for each of the two projects.
b. Assume that the firm’ s cost of capital is 10% and that both projects have 20year lives. Construct a table similar to thi...
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- Fall '13