Capital Budgeting Techniques: Certainty and Risk
Capital Budgeting Techniques: Certainty and Risk
Capital Budgeting Techniques: Certainty and Risk
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Project A<br />
Input Function<br />
42000 CF 0<br />
14000<br />
5<br />
14<br />
Solution<br />
6063.13<br />
CF 1<br />
N<br />
I<br />
NPV<br />
CHAPTER 9 <strong>Capital</strong> <strong>Budgeting</strong> <strong>Techniques</strong>: <strong>Certainty</strong> <strong>and</strong> <strong>Risk</strong> 367<br />
Project B<br />
Input Function<br />
45000 CF 0<br />
28000<br />
12000<br />
10000<br />
3<br />
11<br />
Solution<br />
9798.43<br />
FIGURE 9.8 Calculation of NPVs for Bennett Company’s <strong>Capital</strong> Expenditure Alternatives<br />
using RADRs<br />
Time lines depicting the cash flows <strong>and</strong> NPV calculations using RADRs for projects A <strong>and</strong> B<br />
Project A<br />
0<br />
$42,000<br />
48,063<br />
NPVA = $ 6,063<br />
$54,798<br />
Project B<br />
0<br />
$45,000<br />
25,225<br />
9,739<br />
7,312<br />
6,587<br />
5,935<br />
NPVB = $ 9,798<br />
1<br />
$14,000<br />
1<br />
$28,000<br />
k = 11%<br />
k = 11%<br />
2<br />
$14,000<br />
2<br />
$12,000<br />
End of Year<br />
k = 14%<br />
End of Year<br />
k = 11%<br />
3<br />
$14,000<br />
3<br />
$10,000<br />
CF 1<br />
CF 2<br />
CF 3<br />
N<br />
I<br />
NPV<br />
k = 11%<br />
4<br />
$14,000<br />
4<br />
$10,000<br />
k = 11%<br />
5<br />
$14,000<br />
5<br />
$10,000<br />
Note: When we use the risk indexes of 1.6 <strong>and</strong> 1.0 for projects A <strong>and</strong> B, respectively, along with the table in the middle of the preceding page, a<br />
risk-adjusted discount rate (RADR) of 14% results for project A <strong>and</strong> a RADR of 11% results for project B.
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