Foundations Of Finance
10th Edition
ISBN: 9780134897264
Author: KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher: Pearson,
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Chapter 11, Problem 20SP
(Risk-adjusted discount rates and risk classes) The G. Wolfe Corporation is examining two capital-budgeting projects with 5-year lives. The first, project A, is a replacement project; the second, project B, is a project unrelated to current operations. The G. Wolfe Corporation uses the risk-adjusted discount rate method and groups projects according to purpose, and then it uses a required rate of return or discount rate that has been preassigned to that purpose or risk class. The expected cash flows for these projects are given here:
The purpose/risk classes and preassigned required
Determine each project’s risk-adjusted
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A company wants to decide which project to undertake out of two projects A and B. For this purpose, it wants to evaluate each project that have the same initial investment (cost) but different cash flows for the next three years. The following table gives information on these two projects. The discount rate to be used is 8 percent, which is the WACC for the company. Use two methods of capital budgeting: The Net Present Value (NPV) Method and the Internal Rate of Return (IRR) Method, to evaluate and compare the two projects. Based on the outcome of calculations, choose the best project A or B and explain your decision for each method. Show all your work for each method step by step.
Initial Investment and Cash Flows of
Projects A and B in AED
Project A
Project B
Initial Investment
- 150,000
- 150,000
Year 1 Cash flow
20,000
50,000
Year 2 Cash flow
90,000
90,000
Year 3 Cash flow
70,000
60,000
Assume the following information for a capital budgeting proposal with a five-year time horizon:
Initial investment:
Cost of equipment (zero salvage value)
Annual revenues and costs:
Sales revenues
Variable expenses
Depreciation expense
Fixed out-of-pocket costs.
Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using the tables provided.
If the company's discount rate is 12%, then the net present value for this investment is closest to:
Multiple Choice
$241,600.
$(141,600).
$ 530,000
$ 300,000
$ 130,000
$ 50,000
$ 40,000
You are a financial analyst for the Hittle Company. The director of capital budgeting has asked you to
analyze six proposed capital investments. Each project has a cost of $1,000, and the required rate of
return for each is 12%, determine for each project (a) the payback period, (b) the net present value,
(c) the profitability index, and (d) the internal rate of return. Assume under MACRS the asset falls in
the three-year property class and that the corporate tax rate is 25 percent. You are limited to a
maximum expenditure of $3000 only for this capital budgeting period. Which projects you will
accept and why? Justify your suggestions
Project A
Project B
Project C
Project D
Project E
Project F
Investment
-1000
-1000
-1000
-1000
-1000
-1000
1
150
200
250
800
900
1000
2
350
300
250
350
300
200
3
400
500
600
200
150
100
4
700
650
600
200
150
50
12 Capital Budgeting and Estimating Cash Flows
Table 12.2
PROPERTY CLASS
RECOVERY
YEAR
MACRS depreciation
percentages
3-YEAR
5-YEAR
7-YEAR
10-YEAR…
Chapter 11 Solutions
Foundations Of Finance
Ch. 11.A - Prob. 1MCCh. 11.A - Prob. 2MCCh. 11 - Prob. 1RQCh. 11 - Prob. 2RQCh. 11 - If a project requires an additional investment in...Ch. 11 - Prob. 4RQCh. 11 - Prob. 5RQCh. 11 - Prob. 6RQCh. 11 - Prob. 1SPCh. 11 - (Relevant cash flows) Captins Cereal is...
Ch. 11 - Prob. 3SPCh. 11 - Prob. 4SPCh. 11 - Prob. 5SPCh. 11 - Prob. 6SPCh. 11 - Prob. 7SPCh. 11 - Prob. 9SPCh. 11 - Prob. 10SPCh. 11 - Prob. 11SPCh. 11 - Prob. 12SPCh. 11 - Prob. 15SPCh. 11 - (Real options and capital budgeting) You have come...Ch. 11 - (Real options and capital budgeting) Go-Power...Ch. 11 - (Real options and capital budgeting) McDoogals...Ch. 11 - (Risk-adjusted NPV) The Hokie Corporation is...Ch. 11 - (Risk-adjusted discount rates and risk classes)...Ch. 11 - Prob. 1MCCh. 11 - Prob. 2MCCh. 11 - Prob. 3MCCh. 11 - Prob. 7MCCh. 11 - Prob. 8MCCh. 11 - Prob. 9MCCh. 11 - Should the project be accepted? Why or why not?Ch. 11 - Prob. 11MCCh. 11 - Prob. 12MCCh. 11 - Prob. 13MCCh. 11 - Prob. 14MC
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- Moses Manufacturing is attempting to select the best of three mutually exclusive projects, X, Y, and Z. Although all the projects have 5-year lives, they possess differing degrees of risk. Project X is in class V, the highest-risk class; project Y is in class II, the below-average-risk class; and project Z is in class III, the average-risk class. The basic cash flow data for each project and the risk classes and risk-adjusted discount rates (RADRs) used by the firm are shown in the following tables. Project X Project Y Project Z Initial investment (CF0) $179,000 $235,000 $312,000 Year (t ) Cash inflows (CFt) 1 $80,000 $56,000 $85,000 2 66,000 68,000 85,000 3 62,000 73,000 85,000 4 55,000 84,000 85,000 5 65,000 96,000 85,000 Risk Classes and RADRs Risk Class Description Risk adjusted…arrow_forwardScenario: Capital budgeting is utilized to determine if a project is worthwhile. The net present value (NPV), payback period, and internal rate of return (IRR) methods are used to rank and select which project to undertake. The following video outlines the NPV and IRR method of capital budgeting: Explain how to calculate the NPV, IRR, and payback period for each project. Utilizing the capital budgeting calculations, you will need to select the best investment for the company. These calculations will be based on the following scenario: Hunter Shipyard Industries has 3 potential projects to consider, all with an initial cost of $1,250,000. The company prefers to reject any project with a 4-year cut-off period for recapturing initial cash outflow. Given the cost of capital rates and the future cash flow for each project, determine which project the company should accept. Cash Flow Project A Project I Project U Year 1 250,000 450,000 250,000 Year 2 250,000…arrow_forwardthe following information relates to three potential investment projects that are being considered by scrappit pls. due to capital rationing, only one of the three projects can be pursued. a) calculate the payback period, accounting rate of return and net present value of each of the potential project. B) explain which of the three potential investment projects should be undertaken. year explanation should be based on the result of your year calculation in part (a).arrow_forward
- Answer the given question with a proper explanation and step-by-step solution. Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 7%. 0 1 2 3 4 Project A -1,000 600 440 210 260 Project B -1,000 200 375 360 710 What is Project A's payback? Do not round intermediate calculations. Round your answer to four decimal places. ____ years What is Project A's discounted payback? Do not round intermediate calculations. Round your answer to four decimal places. ______ years What is Project B's payback? Do not round intermediate…arrow_forwardUse the information provided to answer the questions Calculate the Accounting Rate of Return (on average investment) of Project B (expressed to twodecimal places).Calculate the Net Present Value of each project (with amounts rounded off to the nearest Rand). Use your answers from previous question to recommend the project that should be chosen. Motivateyour choice.arrow_forwardBlue Spruce Inc. is comparing several alternative capital budgeting projects as shown below: Initial investment Present value of net cash flows O C.B.A OA.C.B. OC.A.B. OAB.C. A Save for Later $102000 112000 Using the profitability index, the projects rank as Projects B $142000 $182000 222000 132000 C & Attempts: 0 of 1 used Submit Answer PriScarrow_forward
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Capital Budgeting Introduction & Calculations Step-by-Step -PV, FV, NPV, IRR, Payback, Simple R of R; Author: Accounting Step by Step;https://www.youtube.com/watch?v=hyBw-NnAkHY;License: Standard Youtube License