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P12-12. Risk classes and RADR
LG 4; Basic
a. Project X
Project Y
Project Z
b. Projects X and Y are acceptable with positive NPVs, while Project Z with a negative NPV is not.
P12-13. Unequal lives—ANPV approach
LG 5; Intermediate
a. Machine A
Machine B
Machine C
Rank Machine
b. Machine A
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Chapter 12 Risk and Refinements in Capital Budgeting 254
Machine B
Machine C
Rank Machine
c. Machine B should be acquired because it offers the highest ANPV. Not considering the difference in
project lives resulted in a different ranking based in part on Machine C’s NPV calculations.
P12-14. Unequal lives—ANPV approach
LG 5; Intermediate
a. Project X
Project Y
Project Z
Rank Project
b. Project X
Project Y
Project Z
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Chapter 12 Risk and Refinements in Capital Budgeting 255
Rank Project
c. Project Y should be acquired because it offers the highest ANPV. Not considering the difference in
project lives resulted in a different ranking based primarily on the unequal lives of the projects.
P12-15. Unequal lives—ANPV approach
LG 5; Intermediate
a. Sell
License
Manufacture
Rank Alternative
b. Sell
Rank Alternative
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Chapter 12 Risk and Refinements in Capital Budgeting 256
P12-16. NPV and ANPV decisions
LG 5; Challenge
a. – b. Unequal-Life Decisions
Annualized Net Present Value (ANPV)
Samsung Sony
P12-17. Real options and the strategic NPV
LG 6; Intermediate
a. Value of real options value of abandonment value of expansion value of delay
b. Due to the added value from the options, Rene should recommend acceptance of the capital
c. In general this problem illustrates that by recognizing the value of real options a project that would
P12-18. Capital rationing—IRR and NPV approaches
LG 6; Intermediate
a. Rank by IRR
Project IRR Initial Investment Total Investment
F 23% $2,500,000 $2,500,000
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Projects F, E, and G require a total investment of $4,500,000 and provide a total present value of
$5,200,000 and, therefore, an NPV of $700,000.
b. Rank by NPV (NPV PV – Initial investment)
Project NPV Ini!al Investment
F $500,000 $2,500,000
c. The internal rate of return approach uses the entire $4,500,000 capital budget but provides $200,000
d. The firm should implement Projects B, F, and G, as explained in part c.
P12-19. Capital Rationing—NPV Approach
LG 6; Intermediate
Project Ini!al
investment
NPV at 13% PV
A $300,000 $ 84,000 $384,000
b. The optimal group of projects is Projects C, F, and G, resulting in a total net present value of
P12-20. Ethics problem
LG 4; Challenge
Student answers will vary. Some students might argue that companies should be held accountable for any
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Chapter 12 Risk and Refinements in Capital Budgeting 258
Case
Case studies are available on www.myfinancelab.com.
Evaluating Cherone Equipment’s Risky Plans for Increasing Its Production Capacity
a. 1. Plan X
Plan Y
2. Using a financial calculator, the IRRs are:
b. Plan X
Plan Y
Ranking
Plan NPV IRR RADRs
c. Both NPV and IRR achieved the same rela5ve rankings. However, making risk adjustments through the RADRs caused
d. Plan X
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Chapter 12 Risk and Refinements in Capital Budgeting 259
Plan Y
e. With the addi5on of the value added by the existence of real op5ons, the ordering of the projects is reversed. Project Y
f. Capital ra5oning could change the selec5on of the plan. Because Plan Y requires only $2,100,000 and Plan X requires
Spreadsheet Exercise
Group Exercise
Group exercises are available on www.myfinancelab.com.
Risk within long-term investment decisions is the topic of this chapter. The investment projects of the previous two
Integrative Case 5: Lasting Impressions Company
Integrative Case 5 involves a complete long-term investment decision. The Lasting Impressions Company is a
commercial printer faced with a replacement decision in which two mutually exclusive projects have been
proposed. The data for each press have been designed to result in conflicting rankings when considering the NPV and
IRR decision techniques. The case tests the students’ understanding of the techniques as well as the qualitative
aspects of risk and return decision making.
a. 1. Calcula5on of ini5al investment for Las5ng Impressions Company:
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Chapter 12 Risk and Refinements in Capital Budgeting 260
Press A Press B
Installed cost of new press
Book value $400,000 [(0.20 0.32 0.19) $400,000] $116,000
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2. Depreciation
Year
Cost
Rate
Depreciation
Press A
1
$870,000
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Press B
1
Existing Press
1
$400,000
0.12 (Yr. 4)
5
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Operating cash inflows
Year
Earnings before
Depreciation
and Taxes
Depre-ciation
Earnings
before Taxes
Earnings
after
Taxes
Cash
Flow
Old
Cash
Flow
Incre-
mental
Cash
Flow
Existing Press
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1
$120,000
$48,000
$72,000
$43,200
$91,200
2
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Press A
1
$250,000
$174,000
$76,000
$45,600
$219,600
$91,200
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Press B
1
$210,000
$132,000
$78,000
$46,800
$178,800
$91,200
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2
3. Terminal cash flow
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Chapter 12 Risk and Refinements in Capital Budgeting 268
Press A Press B
After-tax proceeds—sale of new press
* Press A Press B
Sale price $400,000 Sale price $330,000
Cash Flows
Year Press A Press B
Initial investment ($662,000) ($361,600)
* Year 5 Press A Press B
Operating cash flow $191,760 $ 85,680
b.
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c. Relevant cash )ow
Cumulative Cash Flows
Year Press A Press B
1 $128,400 $87,600
1. Press A: 4 years [(662,000 644,440) 191,760]
Press B: 3 years [(361,600 303,040) 85,680]
2. Press A
Press B
3. IRR:
d.
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Data for NPV Profile
Discount Rate
NPV
Press A Press B
0% $432,000 $234,000
e. a. If the rm has unlimited funds, Press A is preferred.
f. The risk would need to be measured by a quan5ta5ve technique such as certainty equivalents or risk-adjusted discount
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