A firm must decide between investing in two alternative risky projects, each requiring the same initial investment. Project A has an equal probability of four possible payoffs: $80m, $100m, $120m or $140m. Project B has a 50:50 chance of a payoff of $90m or $126m. Assuming that the firm’s managers are risk averse, which project would they prefer, and why?

A firm must decide between investing in two alternative risky projects, each requiring the same initial investment. Project A has an equal probability of four possible payoffs: $80m, $100m, $120m or $140m. Project B has a 50:50 chance of a payoff of $90m or $126m. Assuming that the firm’s managers are risk averse, which project would they prefer, and why?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter11: Capital Budgeting And Risk

Section: Chapter Questions

Problem 5P

See similar textbooks

Similar questions

Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 11 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow -1,040 140 460 660 660 260 660 Use the NPV decision rule to evaluate this project; should it be accepted or rejected?
Celestial Crane Cosmetics is analyzing a project that requires an initial investment of $3,225,000. The project's expected cash flows are: Year Cash Flow Year 1 $375,000 Year 2 -125,000 Year 3 500,000 Year 4 400,000 If the company's WACC is 8% and the project has the same risk as the firm's average project, what is the project's modified internal rate of return (MIRR)? Should you accept or reject this project?
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 13 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow -1,110 70 530 730 730 330 730 Use the payback decision rule to evaluate this project; should it be accepted or rejected? Multiple Choice A. 1.10 years, accept B. 4.00 years, reject C. 2.70 years, reject D. 0 years, accept
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 11 percent, and that the maximum allowable payback and discounted payback statistics for your company are 2.5 and 3.0 years, respectively. Time: 0 1 2 3 4 5 Cash flow: −$356,000 $65,700 $83,900 $140,900 $121,900 $81,100 Use the NPV decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.) Should it be accepted or rejected?multiple choice accepted rejected
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 11 percent, and that the maximum allowable payback and discounted payback statistics for your company are 3 and 3.5 years, respectively. Time: 0 1 2 3 4 5 Cash flow: -$280,000 $ 56,800 $75,000 $123,000 $113,000 $72,200 Use the MIRR decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistics for your company are 2.5 and 3.0 years, respectively. Time: 0 1 2 3 4 5 Cash flow: −$362,000 $65,300 $83,500 $140,500 $121,500 $80,700 Use the PI decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.) Should it be accepted or rejected?multiple choice accepted rejected
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 13 percent, and that the maximum allowable payback and discounted payback statistics for your company are 3 and 3.5 years, respectively. Time: 0 1 2 3 4 5 Cash flow: −$240,000 $64,800 $83,000 $139,000 $121,000 $80,200 Use the MIRR decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.) MIRR: ____.__%
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 14 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow −1,010 110 490 690 690 290 690 Use the payback decision rule to evaluate this project; should it be accepted or rejected? Multiple Choice 4.00 years, reject 0 years, accept 2.59 years, reject 1.16 years, accept
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow -1,150 30 570 770 770 370 770 Use the NPV decision rule to evaluate this project; should it be accepted or rejected? Multiple Choice A. $968.66, accept B. $2,118.66, accept C. $-495.13, reject D. $864.87, accept
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 11 percent, and that the maximum allowable payback and discounted payback statistics for your company are 2.5 and 3.0 years, respectively. Time: 0 1 2 3 4 5 Cash flow −$231,000 $65,400 $83,600 $140,600 $121,600 $80,800 Use the discounted payback decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.) Discounted payback _____.__ years
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 13 percent, and that the maximum allowable payback and discounted payback statistics for your company are 3 and 3.5 years, respectively. Time: 0 1 2 3 4 5 Cash flow: −$255,000 $61,800 $80,000 $133,000 $118,000 $77,200 Use the MIRR decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.) Should this be Accepted or Rejected
Suppose your firm is evaluating four potential new investments. You calculate that these projects, W, X, Y, and Z,have the NPV and IRR figures given below:Project W: NPV = $7,000 IRR = 13%Project X: NPV = $-4,000 IRR = 15%Project Y: NPV = $5,000 IRR = 10%Project Z: NPV = $800 IRR = 18%a) Which project(s) should be accepted if they are independent? Clearly explain your reasoning.b) Which project(s) should be accepted if they are mutually exclusive? Clearly explain your reasoning.