FIN 450 MODULE 2 PROBLEMS

DOWNLOAD
Breakeven cash inflows and risk Blair Gasses and Chemicals is a supplier of
highly purified to semiconductors manufactures. A large chip producer has
asked Blair to build a new gas production facility close to an existing
semiconductor plant. Once the new gas plant is in place, Blair will be the
excusive supplier for that semiconductor fabrication plant for the subsequent 5
years. Blair is considering one of two plant designs. The firsts standard
plant which will cost $40 million to build. The custom will allow Blair to produce
their highly specialized gases that are required for and emerging
semiconductor manufacturing process. Blair estimates that its clients will order
$10 million of product per year if the traditional plant is constructed, but if the
customized is put in place, Blair expects to sell $15 million worth of products
annually to it clients. Blair has enough money to build either type of plant, and
in the absence of risk difference, accepts the project with the highest NPV.
The cost of capital is 12%.
A)Find the NPV for each project. Are the projects acceptable?
B) Find the breakeven cash inflow for the project.
C) The firm has estimated the probabilities of achieving various ranges of
cash inflow for the two projects as shown in the following table. What is the
probability that each project will achieve the breakeven cash inflow found in
part b?
Probability of achieving
Cash inflow in given range

Range of cash inflow ($ millions)

Standard Plant

Custom Plant

$0 to $5

0%

5%

$5 to $8

10

10

$8 to 11

60

15

$11 to 14

25

25

$14 to 17

20

$17 to 20

15

Above $20

10

d) Which project is more risky? Which project has the potentially higher NPV?
Discuss the risk-return trade-offs of the two projects.
e). If the firm wishes to minimize losses (that is, NPV < $0), which project
would you recommend? Which would you recommend if the goal were to
achieve a higher NPV?
P12-4
Basic scenario Murdock Paints is in the process of evaluating two mutually
exclusive additions to the process capacity. The firms financial analyses
have developed pessimistic, most likely and optimistic estimates of an annual
cash inflows associated with cash projects. The estimates are shown in the
following table.
Project-A

Initial investments (CFo)

Outcome

-$8,000

Project-B

-$8,000

Annual cash flow (CF)

Pessimistic

$200

$900

Most Likely

1,000

1,000

Optimistic

1,800

1,000

a). Determine the range of annual cash inflows for cash of the two operations
b). Assume that the firms cost of capital is10% and that both projects have 20year lives. Construct a table similar to this one for the NPVs for each project.
Include the range of NPVs for each project.
c) Do parts a, and b provide consistent views of the two projects? Explain.
d) Which project do you recommend? Why?
P12-8
Risk adjustment discount rates; Basic Country Wallpaper is considering
investing in one of three mutually exclusive projects, E, F, and G. The firms
cost of capital, r is 15%, and the risk free rate is R, is10%. The firm has
gathered the basic cash flow and risk index data for each project as shown in
the following table.
Projects r
E

Initial investment (CFo)

-$15,000

-$11,000

-$19,000

Cash inflows (CFt)

Years (t)
1

$6,000

$6,000

$4,000

6,000

4,000

6,000

6,000

5,000

8,000

6,000

2,000

12,000

Risk index (R1t)

1.8

1.00

0.60

a). Find the net present value (NPV) of each project using the firms cost of
capital.
Which project is preferred in this situation?
b). The used the following equation ton determine the risk-adjusted discount
rate RADR, for each project j:
RADR j= Rf + [ RIj x (r Rf) ]
P12-12
Risk classes and RADR Moses Manufacturing is attempting to select the best
of three mutually exclusive projects, X, Y, and Z. Although all the projects have
5-year lives, they possess different degrees of risk. Project X is class V, the
highest risk class; project Y is II, the below average risk class; and project Z is
class III, the average risk class. The basic cash flow data for each project and
risk class and risk adjustment discount rates (RADRs) used by the firm are
shown in the following tables.
Project X

Project Y

Initial investment (CFg)

Year (t)

Project Z
-$180,000

-$235,000

-$310,000

Cash inflows (CFt)

$80,000

$50,000

$90,000

$70,000

$60,000

$90,000

60,000

70,000

90,000

60,000

80,000

90,000

60,000

90,000

90,000

Risk Classes and RADRs

Risk class

Descriptions

Risk-adjusted discount

Lowest risk

10%

rate (RADR)
I
II

Below-average risk

III

Average risk

IV

Above average risk

13
15
19

Highest risk

22

a) Find the risk adjusted NPV for each project.

b) Which project if any, would you recommend that the firm undertake?
P12-14
Unequal lives; ANPV approach Portland Products is considering the purchase
of one of three manually exclusive projects for increasing production efficiency.
The firm planes to use a 14% cost of capital to evaluate these equal risk
projects. The initial investment and annual cash inflows over the life of each
project are shown in the following table.
Project X

Project Y

Initial investment (CFo)

Project Z
-$78,000

Year (f)

-$52,000

-$66,000

Cash inflows (CFt)

$17,000

$28,000

25,000

38,000

$15,000
$15,000

33,000

$15,000

$41,000

$15,000

$15,000

$15,000

$15,000

$15,000

a) Calculate the NPV for each project over its life. Rank the project in
descending order on the basis of NVP
b) Use the annualized net present value (ANPV) approach to evaluate and
rank the projects in descending order on the basis of ANPV.
c)Compare and contrast your findings in parts a and b. Which project would
you recommend?
P12-18
Capital rationing; IRR and NPV Valley Corporation is attempting to select the
best of a group of independent projects competing for the firms fixed capital
budget of $4.5 million. The firms recognize that any unused portion of this
budget will less then 15% cost of capital, thereby resulting in a present value
of inflows, that that is less than the initial investment. The firm has
summarized in the following table, the key data to be used in selecting the
best group of projects.
Projects

Initial investments

IRR

-$5,000,000

17%

-800,000

18

-2,000,000

19

Present value of inflows at 15%

$5,400,000
1,100,000
2,300,000

-1,500,000

16

1,600,000

-800,000

22

900,000

-2,500,000

23

3,000,000

-1,200,000

20

1,300,000

a) Use the internal rate of return (IRR) to select the best group of projects.
b) Use the net present value (NPV) approach to select the best group of
projects.
c) Compare, contrast, and discuss your findings in parts a and b.
d) Which project should the firm implement? Why?