978-1259277160 Chapter 13 Solution Manual Part 2

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13-8. Solution:

Coefficient of Variation (V) = Standard deviation/Expected

value

Ranking from

Lowest to Highest

9. Coefficient of variation and time (LO13-1) Digital Technology wishes to determine its

coefficient of variation as a company over time. The firm projects the following data (in

millions of dollars):

Year

Profits:

Expected Value Standard Deviation

……………………………………..

$180 $62

……………………………………..

240 104

……………………………………..

300 166

……………………………………..

400 292

a. Compute the coefficient of variation (V) for each time period.

b. Does the risk (V) appear to be increasing over a period of time? If so, why might this

be the case?

13-9. Solution:

Digital Technology

Year

Profits:

Expected Value

Standard

Deviation

Coefficient

of Variation

b. Yes, the risk appears to be increasing over time. This may

10. Risk-averse (LO13-2) Tim Trepid is highly risk-averse, while Mike Macho actually enjoys

taking a risk.

a. Which one of the four investments should Tim choose? Compute coefficients of

variation to help you in your choice.

Investments

Returns:

Expected Value

Standard

Deviation

Buy stocks……………………….. $ 9,140 $ 6,140

Buy bonds………………………… 7,680 2,560

Buy commodity futures……… 19,100 26,700

Buy options……………………… 17,700 18,200

b. Which one of the four investments should Mike choose?

13-10. Solution:

Coefficient of Variation (V) = Standard Deviation / Expected

Value

a. Tim should buy the bonds because bonds have the lowest

b. Mike should buy the commodity futures because they have

11. Risk-averse (LO13-2) Mountain Ski Corp. was set up to take large risks and is willing to

take the greatest risk possible. Lakeway Train Co. is more typical of the average

corporation and is risk-averse.

a. Which of the following four projects should Mountain Ski Corp. choose? Compute

the coefficients of variation to help you make your decision.

b. Which one of the four projects should Lakeway Train Co. choose based on the same

criteria of using the coefficient of variation?

Year

Returns:

Expected Value Standard Deviation

13-11. Solution:

Mountain Ski Corp. and Lakeway Train Co.

Coefficient of Variation (V) = Standard Deviation / Expected

Value

a. Mountain Ski Corp should choose Project C because it has

b. Lakeway Train Co. should choose Project B because it has

12. Coefficient of variation and investment decision (LO13-1) Kyle’s Shoe Stores Inc. is

considering opening an additional suburban outlet. An aftertax expected cash flow of $130

per week is anticipated from two stores that are being evaluated. Both stores have positive

net present values.

Which store site would you select based on the distribution of these cash flows? Use

the coefficient of variation as your measure of risk.

Site A Site B

Probability Cash Flows Probability Cash Flows

.3 80 .2 50

.3 130 .2 80

.1 160 .3 130

.3 170 .1 180

.2 235

13-12. Solution:

Kyle’s Shoe Stores Inc.

Standard Deviations of Sites A and B

Site A

( )D D–

Site A is the preferred site since it has the smallest coefficient of

13. Risk-adjusted discount rate (LO13-3) Waste Industries is evaluating a $70,000 project

with the following cash flows:

Year Cash Flows

……………………..

$11,000

……………………..

16,000

……………………..

21,000

……………………..

24,000

……………………..

30,000

The coefficient of variation for the project is .847.

Based on the following table of risk-adjusted discount rates, should the project be

undertaken? Select the appropriate discount rate and then compute the net present value.

Coefficient

of Variation Discount Rate

0 – .25……………… 6%

.26 – .50……………… 8

.51 – .75……………… 10

.76 – 1.00……………… 14

1.01 – 1.25………………. 20

13-13. Solution:

Waste Industries

Year Inflows PVIF @ 14% PV

Based on the negative net present value, the project should not

be undertaken.

Calculator solution:

Find the PV of cash inflow using a financial calculator at 14 percent:

Press the following keys: 2nd, CF, 2nd, Clear.

Calculator displays CFo, enter 70,000 and press +|–, press the Enter key.

Press down arrow, enter 11,000, and press Enter.

Press down arrow, enter 1, and press Enter.

14. Risk-adjusted discount rate (LO13-3) Dixie Dynamite Company is evaluating two

methods of blowing up old buildings for commercial purposes over the next five years.

Method one (implosion) is relatively low in risk for this business and will carry a 12

percent discount rate. Method two (explosion) is less expensive to perform but more

dangerous and will call for a higher discount rate of 16 percent. Either method will require

an initial capital outlay of $75,000. The inflows from projected business over the next five

years are given next. Which method should be selected using net present value analysis?

Years Method 1 Method 2

……………………..

$18,000 $20,000

……………………..

24,000 25,000

……………………..

34,000 35,000

……………………..

26,000 28,000

……………………..

14,000 15,000

13-14. Solution:

Dixie Dynamite Co.

Method 1 Method 2

Year Inflows

PVIF

12% PV Inflows

PVIF

16% PV

Select Method 1

Calculator solution:

Method 1:

Find the PV of cash inflow using a financial calculator at 12 percent:

Press the following keys: 2nd, CF, 2nd, Clear.

Calculator displays CFo, enter 75,000 and press +|–, press the Enter key.

Press down arrow, enter 18,000, and press Enter.

Press down arrow, enter 1, and press Enter.

Press down arrow, enter 24,000, and press Enter.

Press down arrow, enter 1, and press Enter.

Press down arrow, enter 34,000, and press Enter.

Method 2:

Find the PV of cash inflow using a financial calculator at 16 percent:

Press the following keys: 2nd, CF, 2nd, Clear.

Calculator displays CFo, enter 75,000 and press +|–, press the Enter key.

Press down arrow, enter 20,000, and press Enter.

Press down arrow, enter 1, and press Enter.

Press down arrow, enter 25,000, and press Enter.

Solution: Select Method 1

15. Discount rate and timing (LO13-1) Fill in the following table from Appendix B. Does a

high discount rate have a greater or lesser effect on long-term inflows compared to recent

ones?

Discount Rate

Years 5% 20%

…………………………….

_______ _______

…………………………….

_______ _______

…………………………….

_______ _______

13-15. Solution:

Discount Rate

Years 5% 20%

The impact of a high discount rate is much greater on long-term

value. For example, after the first year, the high rate discount

16. Expected value with net present value (LO13-1) Debby’s Dance Studios is considering

the purchase of new sound equipment that will enhance the popularity of its aerobics

dancing. The equipment will cost $27,900. Debby is not sure how many members the new

equipment will attract, but she estimates that her increased annual cash flows for each of

the next five years will have the following probability distribution. Debby’s cost of capital

is 15 percent.

Cash Flow Probability

$4,570

…………………………………….. .1

5,550

…………………………………….. .3

7,400

…………………………………….. .4

9,930

…………………………………….. .2

a. What is the expected value of the cash flow? The value you compute will apply to

each of the five years.

b. What is the expected net present value?

c. Should Debby buy the new equipment?

13-16. Solution:

Debby’s Dance Studios

a. Expected Cash Flow

Cash Flow P

b. Net Present Value (Appendix D)

$7,068 × 3.352 (PVIFA @ 15%, n = 5) =

c. Debby should not buy this new equipment because the net

present value is negative.

Calculator solution:

Find the PV of cash inflow using a financial calculator at 15 percent:

Press the following keys: 2nd, CF, 2nd, Clear.

17. Deferred cash flows and risk-adjusted discount rate Highland Mining and Minerals Co.

is considering the purchase of two gold mines. Only one investment will be made. The

Australian gold mine will cost $1,649,000 and will produce $353,000 per year in years 5

through 15 and $503,000 per year in years 16 through 25. The U.S. gold mine will cost

$2,054,000 and will produce $282,000 per year for the next 25 years. The cost of capital is

13 percent.

a. Which investment should be made? (Note: In looking up present value factors for this

problem, you need to work with the concept of a deferred annuity for the Australian

mine. The returns in years 5 through 15 actually represent 11 years; the returns in

years 16 through 25 represent 10 years.)

b. If the Australian mine justifies an extra 2 percent premium over the normal cost of

capital because of its riskiness and relative uncertainty of cash flows, does the

investment decision change?