The following table summarizes the cash flows internal rate of return IRR and

# The following table summarizes the cash flows

• Test Prep
• EarlResolveMouse8799
• 44
• 91% (22) 20 out of 22 people found this document helpful

This preview shows page 18 - 21 out of 44 pages.

the projects will be repeated. The following table summarizes the cash flows, internal rate of return (IRR), and risk of each of the projects. Year (t) Project A Project B Project C Project D Project E 0 -\$200,000 -\$100,000 -\$100,000 -\$100,000 -\$100,000 1 66,000 30,000 30,000 30,000 40,000 2 66,000 30,000 30,000 30,000 25,000 3 66,000 40,000 30,000 40,000 30,000 4 66,000 40,000 40,000 50,000 35,000 IRR 12.110% 14.038% 10.848% 16.636% 11.630% Project Risk Below Average Below Average Average Above Av- erage Above Av- erage Which projects will the firm select for investment? a. Projects: A, B, C, D, E b. Projects: B, C, D, E c. Projects: B, D d. Projects: A, D e. Projects: B, C, D Page 18 Chapter 13: Capital Budgeting: Cash Flows and Risk
(13.6) Scenario analysis Answer: c Diff: M 66 . Klott Company encounters significant uncertainty with its sales volume and price in its primary product. The firm uses scenario analysis in order to determine an expected NPV, which it then uses in its budget. The base case, best case, and worse case scenarios and probabilities are provided in the table below. What is Klott's expected NPV, standard deviation of NPV, and coefficient of variation of NPV? Probability Unit Sales Sales NPV of Outcome Volume Price (In Thousands) Worst case 0.30 6,000 \$3,600 -\$6,000 Base case 0.50 10,000 4,200 +13,000 Best case 0.20 13,000 4,400 +28,000 a. Expected NPV = \$35,000; σ NPV = 17,500; CV NPV = 2.00. b. Expected NPV = \$35,000; σ NPV = 11,667; CV NPV = 0.33. c. Expected NPV = \$10,300; σ NPV = 12,083; CV NPV = 1.17. d. Expected NPV = \$13,900; σ NPV = 8,476; CV NPV = 0.61. e. Expected NPV = \$10,300; σ NPV = 13,900; CV NPV = 1.35. (13.8) Risk-adjusted NPV Answer: a Diff: M 67 . Virus Stopper Inc., a supplier of computer safeguard systems, uses a cost of capital of 12 percent to evaluate average-risk projects, and it adds or subtracts 2 percentage points to evaluate projects of more or less risk. Currently, two mutually exclusive projects are under consid- eration. Both have a cost of \$200,000 and will last 4 years. Project A, a riskier-than-average project, will produce annual end of year cash flows of \$71,104. Project B, of less than average risk, will produce cash flows of \$146,411 at the end of Years 3 and 4 only. Virus Stopper should accept a. B with a NPV of \$10,001. b. Both A and B because both have NPVs greater than zero. c. B with a NPV of \$8,042. d. A with a NPV of \$7,177. e. A with a NPV of \$15,968. Chapter 13: Capital Budgeting: Cash Flows and Risk Page 19
(13.8) Risk-adjusted NPV Answer: c Diff: M 68 . Real Time Systems Inc. is considering the development of one of two mu- tually exclusive new computer models. Each will require a net invest- ment of \$5,000. The cash flow figures for each project are shown below: Period Project A Project B 1 \$2,000 \$3,000 2 2,500 2,600 3 2,250 2,900 Model B, which will use a new type of laser disk drive, is considered a high-risk project, while Model A is of average risk. Real Time adds 2 percentage points to arrive at a risk-adjusted cost of capital when evaluating a high-risk project. The cost of capital used for aver- age-risk projects is 12 percent. Which of the following statements re- garding the NPVs for Models A and B is most correct? a. NPV A = \$380; NPV B = \$1,815.

#### You've reached the end of your free preview.

Want to read all 44 pages?

• Fall '14