978-0134476315 Chapter 12 Solution Manual Part 2

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P12-7 Personal Finance: Impact of inflation on investments (LG 2; Easy)

a.  c.

Year

Investmen

t Cash

Flows

Current

NPV (a)

Higher

Inflation

NPV (b)

Lower

Inflation

NPV (c)

(40,000)

12,000

(40,000)

11,267.61

(40,000)

11,111.11

(40,000)

11,428.57

d. If the primary effect of inflation is to raise the discount rate, then NPV will fall. Of course, for

which case the relationship between changes in the inflation rate and NPV is less clear.

P12-8 Simulation (LG 2; Intermediate)

a. Ogden Corporation could use a computer simulation to generate the probability distribution for

NPV by randomly generating cash outflows and cash inflows based on the assumed

distribution (normal) and statistical parameters (mean, standard deviation) for these two inputs.

b. The advantages to computer simulations include the decision maker’s ability to view a

continuum of risk-return tradeoffs instead of a single-point estimate. The computer simulation,

however, is not feasible for risk analysis.

P12-9 Risk-adjusted discount rates: Basic (LG 4; Intermediate)

Project E, with the highest NPV, is preferred.

b. RADRE  0.10  (1.80  (0.15  0.10))  0.19 RADRG  0.10  (0.60 

changes. Project G has the highest NPV in the risk-adjusted analysis and should, therefore, be

chosen.

P12-10 Risk-adjusted discount rates—Tabular (LG 4; Intermediate)

a. Project A

Upfront project cost = $20,000 Project B

Upfront project cost = $30,000

Number of years  5

P12-11 Personal Finance: Mutually exclusive investment and risk (LG 4; Intermediate)

a. Number of years  6, cost of capital  8.5%, annual cash inflows  $3,000;

b. Number of years  6, cost of capital  10.5%, annual cash inflows  $3,800;

upfront project cost = $12,000

c. Using NPV as her guide, Lara should select the second investment with the higher NPV.

d. The second investment is riskier. The higher required return implies a higher risk factor.

P12-12 Risk-adjusted rates of return using CAPM (LG 4; Challenge)

a. rX  7%  1.2(12%  7%)  7%  6%  13%

rY  7%  1.4(12%  7%)  7%  7%  14%

NPV calculation for X:

NPV = Present value of cash inflows – Upfront project cost

NPV calculation for Y:

Number of years = 4, cost of capital = 14%

b. If a straight 12% discount rate is used for both projects, project Y has the higher NPV. But

when, RADRs are used to discount the cash flows, project X has the higher NPV. Because the

two projects have different levels of risk, the RADR approach is preferred.

P12-13 Risk classes and RADR (LG 4; Basic)

a. Project X

Number of years = 5, cost of capital (RADR)  22%

Solve for NPV  $14.930.45

Project Y

Number of years = 5, cost of capital (RADR)  13%

Project Z

Number of years = 5, cost of capital (RADR)  15%, upfront project cost  $310,000

b. Projects X and Y are acceptable with positive NPVs, while Project Z with a negative NPV is

not. Project X, with the higher NPV, should be undertaken.

P12-14 Unequal lives: ANPV approach (LG 5; Intermediate)

a. Machine A

Project cost (CF0)  −$92,000, cash inflows (CF1-6)  $12,000; number of years = 6;

and cost of capital  12%.

Solve for NPV  $7,643.29

Rank Machine

3 A

Note: Machine A is not acceptable and can be rejected without any additional analysis.

b. Machine A

Number of years  6, cost of capital  12%, PV  $42,663.11

Machine B

Number of years  4, cost of capital  12%, PV  $6,646.58

c. Machine B should be acquired because it offers the highest ANPV. The ranking without

consideration of the difference in project lives puts Machine C on top.

P12-15 Unequal lives: ANPV approach (LG 5; Intermediate)

a. Project X

Cash flows: CF0  −$78,000, CF1  $17,000, CF2  $25,000, CF3  $33,000, CF4  $41,000

Cost of capital  14%

Solve for NPV  $3,582.96 Rank Project

b. Project X

Number of periods  4, cost of capital  14%, PV  $

c. Project Y should be acquired because it offers the highest ANPV. The ranking without

consideration of the difference in project lives puts project Z on top.

P12-16 Unequal lives: ANPV approach (LG 5; Intermediate)

a. Sell

Cash flows: project cost (CF0)  −$200,000, CF1  $200,000, CF2  $250,000; and

cost of capital  12%. Solve for NPV  $177,869.90

License

Rank Alternative

b. Sell

Number of years 2, cost of capital  12%, PV  $

Solve for ANPV (annual payment equivalent project NPV)  $105,245.28

License

c. Comparing NPVs of projects with unequal lives favors projects with cash flows over longer periods.

P12-17 NPV and ANPV decisions (LG 5; Challenge)

a. – b. Unequal-Life Decisions

Annualized Net Present Value (ANPV)

Samsung Sony

Cost

Annual Benefits

$(2,350)

$900

$(2,700)

$1,000

a. Cash flows: Upfront cost (CF0)  −$2,350, CF1  $900, CF2  $900, CF3  $900 + $400 

$1,300; and discount rate  9%. Solve for NPVSamsung  $237.04.

b. Number of years  3, discount rate  9%, and PV  $237.04.

d. Number of years  4, discount rate  9%, and PV  $787.67. Solve for ANPVSony  $243.13.

e. Richard and Linda should select the Sony set because its ANPV of $243.13 is greater than the

$93.64 ANPV of Samsung.

P12-18 Real options and the strategic NPV (LG 6; Intermediate)

a. Value of real options  value of abandonment  value of expansion  value of delay

b. Because of the added value from the options, Rene should recommend acceptance of the

capital expenditures for the equipment.

c. In general this problem illustrates recognizing the value of real options can transform a project

P12-19 Capital rationing—IRR and NPV approaches (LG 6; Intermediate)

a. Rank by IRR

Project IRR Initial Investment Total Investment

A 17

D 16

Projects F, E, and G require a total investment of $4,500,000 and provide a total present value

b. Rank by NPV (NPV  PV – Initial investment)

Project NPV Initial Investment

F $500,000 $2,500,00

A 400,000 5,000,000

C 300,000 2,000,000

Project A can be eliminated because, while it has an acceptable NPV, its initial investment

exceeds the capital budget. Projects F and C require a total initial investment of $4,500,000

c. The internal rate of return approach uses the entire $4,500,000 capital budget but provides

d. The firm should implement Projects B, F, and G, as explained in part c.

P12-20 Capital Rationing: NPV Approach (LG 6; Intermediate)

Project Initial investment NPV at 13% PV

A $300,000 $ 84,000 $384,000

B 200,000 10,000 210,000

C 100,000 25,000 125,000

b. The optimal group of projects is Projects C, F, and G, resulting in a total net present value of

found using the net present value approach.

P12-21 Ethics problem (LG 4; Challenge)

Student answers will vary. Some students might argue that companies should be held accountable

for any and all pollution that they cause. Other students may take the larger view that the appropriate