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Capital Budgeting and Risk
16. Expected value = $100,000; Most optimistic estimate = $175,000;
A z value from Table V that leaves 10 percent in either tail is
approximately z = 1.28, therefore
The probability of a value less than $0 is:
17. ßu = ßl/[1 + (1-T)(B/E)] = 1.7/[1 + .6(60/40)] = 0.895
Therefore accept the project for any after-tax cost of debt of
9.2% or less.
18. a. NPV = – $10 million + $2 million (PVIFA0.12,10)
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Capital Budgeting and Risk
b. NPV = – $10 million + $2 million (PVIFA0.17,10)
c. The project should not be accepted because its NPV is
19. P(IRR < 12%) = 10.0%
From Table V, 10.0% corresponds to – 1.28
P(IRR < 14%):
20. NPV = -$5.0 million + ($7.0 million + $0.5 million) / 1.10
21. z = ($0 – $3.0 million) / $ 4.0 million = – 0.75
22. Calculation of beta for Financial Services Division:
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Chapter 11
Capital Budgeting and Risk
Calculation of unlevered beta for Financial Services Division:
Calculation of levered beta for Financial Services Division:
Calculation of required return on equity for Financial Services Division:
Calculation of weighted marginal cost of capital for “new” projects
in Financial Services Division:
23. P(NCF1 < – $10,000) = 10.0%
From Table V, 10.0% corresponds to -1.28
P(NCF1 < $0):
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Chapter 11
Capital Budgeting and Risk
P(z < – 1.17) = 0.1210 or 12.1% from Table V
25. Unlever beta for Dietz:
Relever beta for Muench:
Required equity return for Muench:
Risk-adjusted required return for the Retail Outlet division of Muench:
26. NPV = -$15,000 + $10,000(PVIF0.12,1) + $8,000(PVIF0.12,2)
z = (0 – $9,102) / $3,000 = -3.03
27. No recommended solution.
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Chapter 11
Capital Budgeting and Risk
28. Plus or minus 10% corresponds to plus or minus 1.28
a. The probability that the project will be acceptable is equal to the
probability of it having an NPV great than $0, or:
b. z = [$1 – $1.5] / $1.95 = -0.26
The probability that this project will be acceptable is the probability
of having a net present value greater than $0. The z-score calculation
is:
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Chapter 11
Capital Budgeting and Risk
From Table V, the probability of having a positive NPV (z greater than +0.55
is 29.12%.
b. Other factors to consider:
Real options to expand, cancel and for production Nexibility
SOLUTION TO INTEGRATIVE CASE PROBLEM:
CAPITAL BUDGETING AND RISK ANALYSIS
1. Calculation of net investment:
New equipment $275,000
2.
Operating
Year Revenues Costs Depreciation Tax OEAT NCF
1 $842,875 $600,000 $42,870 $80,002 $120,003 $162,873
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Chapter 11
Capital Budgeting and Risk
6 1,127,957 1,011,035 26,760 36,065 54,097 80,857
*Operating cash Now only for year 10
4. Yes. The project has a positive net present value.
5. Yes. Net cash Nows for the Krst three years total $474,394, which
7.
Operating
Year Revenues Costs Depreciation Tax OEAT NCF
1 $674,300 $600,000 $42,870 $12,572 $18,858 $61,728
2 714,758 666,000 73,470 -9,885 -14,827
58,643 3 757,643 739,260 52,470 -13,635
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Chapter 11
Capital Budgeting and Risk
*Operating cash Now only for year 10
Therefore, do not make the investment.
8.
Operating
Year Revenues Costs Depreciation Tax OEAT NCF
1 $842,875 $600,000 $42,870 $80,002 $120,003 $162,873
2 893,448 678,000 73,470 56,791 85,187
158,657 3 947,054 766,140 52,470 51,378
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Chapter 11
Capital Budgeting and Risk
1,267,372 1,411,563 13,380 -63,028 -94,543 -81,163 9
*Operating cash Now only for year 10
Do not establish the collection subsidiary under these conditions.
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