Toby Amberville’s Manhattan Café, Inc., is considering investment in two alternative capital budgeting projects. Project A is an investment of $75,000 to replace working but obsolete refrigeration equipment. Project B is an investment of $150,000 to expand dining roomfacilities.Relevant cash flowdata forthe two projects over their expected two-year lives are: Project A year 1 year 2 probability cash flow probability cash flow 0.18 0 $ 0.08 0 $ 0.64 50,000 $ 0.084 50,000 0.18 100,000 0.08 100,00 Project B year 1 year 2 probability cash flow probability cash flow 0.50 0 $ 0.125 0 $ 0.50 200,000 0.75 100,000 0.125 200,000 A. Calculate the expected value, standard deviation, and coefficient of variation for cash flows from each project. B. Calculate the risk-adjusted NPV for each project using a 15% cost of capital for the riskier project and a 12% cost of capital for the less risky one. Which project is preferred using the NPV criterion? C. Calculate the PI for each project, and rank the projects according to the PI criterion. D. Calculate the IRR for each project, and rank the projects according to the IRR criterion. E. Compare your answers to parts B, C, and D, and discuss any differences.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter11: Capital Budgeting And Risk

Section: Chapter Questions

Problem 26P

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Toby Amberville’s Manhattan Café, Inc., is considering investment in two alternative capital budgeting projects. Project A is an investment of $75,000 to replace working but obsolete refrigeration equipment. Project B is an investment of $150,000 to expand dining roomfacilities.Relevant cash flowdata forthe two projects over their expected two-year lives are:

Project A

year 1		year 2
probability	cash flow	probability	cash flow
0.18	0 $	0.08	0 $
0.64	50,000 $	0.084	50,000
0.18	100,000	0.08	100,00
Project B
year 1		year 2
probability	cash flow	probability	cash flow
0.50	0 $	0.125	0 $
0.50	200,000	0.75	100,000
		0.125	200,000

A. Calculate the expected value, standard deviation, and coefficient of variation for cash flows from each project.

B. Calculate the risk-adjusted NPV for each project using a 15% cost of capital for the riskier project and a 12% cost of capital for the less risky one. Which project is preferred using the NPV criterion?

C. Calculate the PI for each project, and rank the projects according to the PI criterion.

D. Calculate the IRR for each project, and rank the projects according to the IRR criterion.

E. Compare your answers to parts B, C, and D, and discuss any differences.

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