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a. Compute the net present value of this project assuming it possesses average risk. b. Because of the risk inherent in this type of investment, Seminole has decided to employ the certainty equivalent approach. After considerable discussion, man- agement has agreed to apply the following certainty equivalents to the project's cash flows: Year at 1.00 1 0.95 2 0.90

a. Compute the net present value of this project assuming it possesses average risk. b. Because of the risk inherent in this type of investment, Seminole has decided to employ the certainty equivalent approach. After considerable discussion, man- agement has agreed to apply the following certainty equivalents to the project's cash flows: Year at 1.00 1 0.95 2 0.90

EBK CONTEMPORARY FINANCIAL MANAGEMENT
EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN:9781337514835
Author:MOYER
Publisher:MOYER
Chapter11: Capital Budgeting And Risk
Section: Chapter Questions
Problem 11P
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11. The Seminole Production Company is analyzing the investment in a new line of business machines. The initial outlay required is $35 million. The net cash flows expected from the investment are as follows: INTERMEDIATE Year Net Cash Flow (Million) 1 $5 2 8 3 15 4 20 15 10 7 4 The firm's cost of capital (used for projects of average risk) is 15 percent. a. Compute the net present value of this project assuming it possesses average risk. b. Because of the risk inherent in this type of investment, Seminole has decided to employ the certainty equivalent approach. After considerable discussion, man- agement has agreed to apply the following certainty equivalents to the projecť's cash flows: Year at 1.00 1 0.95 2 0.90 3 0.80 4 0.60 5 0.40 0.35 7 0.30 If the risk-free rate is 9 percent, compute the project's certainty equivalent net present value. c. On the basis of the certainty equivalent analysis, should the project be accepted?
Transcribed Image Text:11. The Seminole Production Company is analyzing the investment in a new line of business machines. The initial outlay required is $35 million. The net cash flows expected from the investment are as follows: INTERMEDIATE Year Net Cash Flow (Million) 1 $5 2 8 3 15 4 20 15 10 7 4 The firm's cost of capital (used for projects of average risk) is 15 percent. a. Compute the net present value of this project assuming it possesses average risk. b. Because of the risk inherent in this type of investment, Seminole has decided to employ the certainty equivalent approach. After considerable discussion, man- agement has agreed to apply the following certainty equivalents to the projecť's cash flows: Year at 1.00 1 0.95 2 0.90 3 0.80 4 0.60 5 0.40 0.35 7 0.30 If the risk-free rate is 9 percent, compute the project's certainty equivalent net present value. c. On the basis of the certainty equivalent analysis, should the project be accepted?
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