Capital Budgeting Techniques: Certainty and Risk

PROBLEMS
LG1
LG1
Project data are shown as follows:
CHAPTER 9 Capital Budgeting Techniques: Certainty and Risk 373
Risk index Required return (RADR)
0.0 7.0% (risk-free rate, RF) 0.2 8.0
0.4 9.0
0.6 10.0
0.8 11.0
1.0 12.0
1.2 13.0
1.4 14.0
1.6 15.0
1.8 16.0
2.0 17.0
Project A Project B
Initial investment (CF0) $15,000 $20,000
Project life 3 years 3 years
Annual cash inflow (CF) $7,000 $10,000
Risk index 0.4 1.8
a. Ignoring any differences in risk and assuming that the firm’s cost of capital is
10%, calculate the net present value (NPV) of each project.
b. Use NPV to evaluate the projects, using risk-adjusted discount rates (RADRs)
to account for risk.
c. Compare, contrast, and explain your findings in parts a and b.
9–1 Payback period Lee Corporation is considering a capital expenditure that
requires an initial investment of $42,000 and returns after-tax cash inflows of
$7,000 per year for 10 years. The firm has a maximum acceptable payback
period of 8 years.
a. Determine the payback period for this project.
b. Should the company accept the project? Why or why not?
9–2 Payback comparisons Dallas Tool has a 5-year maximum acceptable payback
period. The firm is considering the purchase of a new machine and must choose
between two alternative ones. The first machine requires an initial investment of
$14,000 and generates annual after-tax cash inflows of $3,000 for each of the
next 7 years. The second machine requires an initial investment of $21,000 and
provides an annual cash inflow after taxes of $4,000 for 20 years.
a. Determine the payback period for each machine.