Unformatted text preview: ing table,
given its capital budget of $1 million. Project Initial investment NPV at 13%
cost of capital A $300,000 $ 84,000 B 200,000 10,000 C 100,000 25,000 D 900,000 90,000 E 500,000 70,000 F 100,000 50,000 G 800,000 160,000 a. Calculate the present value of cash inflows associated with each project.
b. Select the optimal group of projects, keeping in mind that unused funds are
costly. CHAPTER 10 CASE Evaluating Cherone Equipment’s Risky Plans for Increasing
Its Production Capacity C herone Equipment, a manufacturer of electronic fitness equipment, wishes
to evaluate two alternative plans for increasing its production capacity to
meet the rapidly growing demand for its key product—the Cardiocycle. After
months of investigation and analysis, the firm has pruned the list of alternatives
down to the following two plans, either of which would allow it to meet the
forecast product demand.
Plan X Use current proven technology to expand the existing plant and semiautomated production line. This plan is viewed as only slightly more
risky than the firm’s current average level of risk. Plan Y Install new, just-developed automatic production equipment in the
existing plant to replace the current semiautomated production line.
Because this plan eliminates the need to expand the plant, it is less
expensive than Plan X, but it is believed to be far more risky because of
the unproven nature of the technology. Cherone, which routinely uses NPV to evaluate capital budgeting projects,
has a cost of capital of 12%. Currently the risk-free rate of interest, RF, is 9%.
The firm has decided to evaluate the two plans over a 5-year time period, at the 462 PART 3 Long-Term Investment Decisions end of which each plan would be liquidated. The relevant cash flows associated
with each plan are summarized in the accompanying table.
Initial investment (CF0)
Year (t) Plan Y $2,700,000 $2,100,000 Cash inflows (CFt) 1 $ 470,000 $ 380,000 2 610,000 700,000 3 950,000 800,000 4 970,000 600,000 5 1,500,000 1,200,000 The firm has determined the risk-adjus...
View Full Document