Question

VII. KORONA Manufacturing is considering investing in either of two mutually exclusive projects, A and B. The firm has a 14 percent cost of capital, and the risk-free rate is currently 9 percent. The initial investment, expected cash inflows, and certainty equivalent factors associated with each of the projects are shown in the following table. Initial investment (II) Project B S 56,000 Year (1) Project A $ 40,000 Certainty Cash inflows equivalent factors (CF) (a) $20,000 0.90 16,000 0.80 12,000 0.60 10,000 0.50 10,000 0.40 Cash inflows (CF) $20,000 25,000 15,000 20.000 10,000 Certainty equivalent factors (0) 0.95 0.90 0.85 0.80 0.80 a) Find the net present value (unadjusted for risk) for each project. b) Find the certainty equivalent net present value for each project c) Compare and discuss your findings in a) and b) above. Which, if either, of the projects do you recommend that the firm accept? Explain. (marks 20)

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

W ' = vura 1x 2 ENG 07:53 24-04-2020 • O X JP196 - X G fix H JF J JJ JK L M N. JP JO NPV: YEAR PV OF 190 191 a 192 193 194 195 196 CF w NPO UNADJUSTED FOR RISK PV FACTOR CF CF AT 14% B -40000 -56000 1.0000 20000 20000 0.8772 16000 25000 0.7695 12000 15000 0.6750 10000 20000 0.5921 10000 10000 0.5194 NPV = 197 PV OF CF A*C -40000.00 17543.86 12311.48 8099.66 5920.80 3875.80 7751.60 B*C -56000.00 17543.86 19236.69 10124.57 11841.61 5193.69 7940.41 198 199 200 u 201 202 203 b 204 205 PV OF PV FACTOR AT 9% CF 906 207 NPV: CERTAINTY EQUIVALENT YEAR CERTAINTY CERTAIN CERTAINTY CERTAIN CF EQUIVALENT CASH FLOW CF EQUIVALENT ASH FLOW PROJECT A FACTOR CCF(A) PROJECT B FACTOR CCF(B) -40000 1 -40000 -56000 -56000 1 20000 0.9 18000 20000 0.95 19000 16000 0.8 12800 25000 22500 12000 0.6 7200 15000 0.85 12750 10000 0.5 5000 20000 0.8 16000 10000 0.4 4000 10000 0.8 8000 o 208 209 210 211 212 213 non 0.9 1.0000 0.9174 0.8417 0.7722 0.7084 0.6499 PV OF CF B*C -56000.00 17431.19 18937.80 9845.34 11334.80 5199.45 6748.59 A*C -40000.00 16513.76 10773.50 5559.72 3542.13 2599.73 -1011.16 u – w N NPV = RATIO PI PBP ARR invest, EAA REPLACEMENTS IRRnpvbeta HPR GMAM EAC MACRS RELEVANT MI-np-ir BETA LEVERED NPV REPLACEMENT BOND ... • : |

- @ vor 1x 2 ENG W 07:55 24-04-2020 ... o X JG223 - JF X JG fx JH I J K L M N O P Q . 214 215 C 216 217 PROJECT B IS BETTER IN BOTH CASES AS PROJECTS ARE MUTUALLY EXCLUSIVE, ONLY ONE OF THEM IS SELECTED UNDER UNADJUSTED RISK CASE, BOTH HAVE POSIITVE NPV, BUT PROJECT B HAS HIGHER NPV UNDER CERTAINTY EQUIVALENT APPROACH, PROJECT A HAS NEGATIVE NPV SO SELECT PROJECT B IT HAS POSITIVE NPV 218 219 220 221 222 223 224 225 226 227 228 229 230 231 232 233 234 235 236 237 220 RATIO PI PBP ARR invest, EAA REPLACEMENTS IRRnpvbeta HPR GMAM EAC MACRS RELEVANT MI-np-ir BETA LEVERED NPV REPLACEMENT BOND ... Đ