bus 320 connect homework 6

Assume a corporation has earnings before depreciation and taxes of $123,000 depreciation of $41,000 and is in a 35 percent tax bracket.

(a)

How much would cash flow be if there were only $21,000 in depreciation? All other factors are the same.(Omit the “$” sign in your response.)

Sensor Technology wishes to determine its coefficient of variation as a company over time. The firm projects the following data (in millions of dollars):

Year

Profits: Expected value

Standard deviation

157

206

226

120

Compute the coefficient of variation (V) for each time period. (Round your answers to 2 decimal places.)

100

Compute the coefficient of variation for each site. (Do not round intermediate calculations. Round your answers to 4 decimal places.)

  Site B

Which store site would you select based on the distribution of these cash flows? Use the coefficient of variation as your measure of risk.

59,100

Years

9,180

13,100

21,700

19,400

25,600

The coefficient of variation for the project is .654.

Discount rate

.26

.50

.51

.75

.76

1.01

1.2

Select the appropriate discount rate.

Compute the net present value. Use Appendix B. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Negative amount should be indicated by a minus sign.  Omit the “$” sign in your response.)

Net present value

$ [removed]  

Based on the net present value should the project be undertaken?

Fill in the table below from Appendix B. (Round your answers to 3 decimal places.)

10%

18%

  [removed]  

What is the impact of a high discount rate on long-term inflows?

Debby’s Dance Studios is considering the purchase of new sound equipment that will enhance the popularity of its aerobics dancing. The equipment will cost $22,400. Debby is not sure how many members the new equipment will attract, but she estimates that her increased annual cash flows for each of the next five years will have the following probability distribution. Debby’s cost of capital is 12 percent.

3,890

.3  

5,330

.2  

8,390

9,880

What is the expected value of the cash flow? (Omit the “$” sign in your response.)

  Expected cash flow

What is the expected net present value? Use Appendix D. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)

  Net present value

 $ [removed]  

(c)

Should Debby buy the new equipment?

Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,630,000 and will produce $306,000 per year in years 5 through 15 and $572,000 per year in years 16 through 25. The U.S. gold mine will cost $2,012,000 and will produce $270,000 per year for the next 25 years. The cost of capital is 10 percent.

Calculate the net present value for each project. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Omit the “$” sign in your response.)

  The Australian Mine

Which investment should be made?

(b-1)

If the Australian Mine justifies an extra 1 percent premium over the normal cost of capital because of its riskiness and the relative uncertainty of cash flows, recalculate the net present value of the mine.(Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)

(b-2)

Does the investment decision change?

Mr. Sam Golff desires to invest a portion of his assets in rental property. He has narrowed his choices down to two apartment complexes, Palmer Heights and Crenshaw Village. After conferring with the present owners, Mr. Golff has developed the following estimates of the cash flows for these properties.

  Palmer Heights

Yearly aftertax cash inflow (in thousands)

$ 90

125

130

  Crenshaw Village

$ 95

Mr. Golff is likely to hold the complex of his choice for 30 years, and he will use this time period for decision-making purposes. Either apartment complex can be acquired for $206,000. Mr. Golff uses a risk-adjusted discount rate when considering investments. His scale is related to the coefficient of variation.

0.20

5  

0.21

0.40

8  

(cost of capital)

0.41

.60

12  

0.60

16  

(a) 

Compute the risk-adjusted net present values for Palmer Heights and Crenshaw Village. (Omit the “$” sign in your response.)

Which investment should Mr. Golff accept if the two investments are mutually exclusive?

Which investment should Mr. Golff accept If the investments are not mutually exclusive and no capital rationing is involved?

Allison’s Dresswear Manufacturers is preparing a strategy for the fall season. One alternative is to expand its traditional ensemble of wool sweaters. A second option would be to enter the cashmere sweater market with a new line of high-quality designer label products. The marketing department has determined that the wool and cashmere sweater lines offer the following probability of outcomes and related cash flows.

EXPAND WOOL SWEATERS LINE

ENTER CASHMERE SWEATERS LINE

Expected sales

Present value of cash flows from sales

  Fantastic

262,000

378,000

  Moderate

194,000

239,000

  Low

88,100

The initial cost to expand the wool sweater line is $161,000. To enter the cashmere sweater line the initial cost in designs, inventory, and equipment is $136,000.

Calculate Net present value. (Negative amounts should be indicated by a minus sign. Omit the “$” sign in your response.)

  Expand wool sweaters line

  Enter cashmere sweaters line

When returns from a project can be assumed to be normally distributed (represented by a symmetrical, bell-shaped curve), the areas under the curve can be determined from statistical tables based on standard deviations. For example, 68.26 percent of the distribution will fall within one standard deviation of the expected value (     ± 1σ). Similarly 95.44 percent will fall within two standard deviations (      ± 2σ), and so on. An abbreviated table of areas under the normal curve is shown here.

Number of σ’s from expected value

+ or –

+ and –

.50  

.1915  

.3830  

1.00  

.3413  

.6826  

1.50  

.4332  

.8664  

1.7

.4599  

.9198  

2.00  

.4772  

.9544  

Assume Project A has an expected value of $34,000 and a standard deviation ( σ ) of $6,800.

What is the probability that the outcome will be between $23,800 and $44,200? (Round your answer to 4 decimal places.)

  Probability

What is the probability that the outcome will be between $20,400 and $47,600? (Round your answer to 4 decimal places.)

What is the probability that the outcome will be at least $20,400? (Round your answer to 4 decimal places.)

(d)

What is the probability that the outcome will be less than $45,920? (Round your answer to 4 decimal places.)

(e)

What is the probability that the outcome will be less than $30,600 or greater than $40,800? (Round your answer to 4 decimal places.)

Company

Year 1

Year 5

Year 10

Cash inflow

.40  

.35  

.20  

.30  

The expected value for all three years is $60.

Compute the standard deviation for each of the three years. (Round your answers to 2 decimal places.)

  Year 1

  Year 5

  Year 10

Treynor Pie Co. is a food company specializing in high-calorie snack foods. It is seeking to diversify its food business and lower its risks. It is examining three companies—a gourmet restaurant chain, a baby food company, and a nutritional products firm. Each of these companies can be bought at the same multiple of earnings. The following represents information about the companies.

Correlation with Treynor Pie company

Sales ($ millions)

Expected earnings($ millions)

Standard deviation in earnings ($ millions)

  Treynor Pie Company

182

3.0

  Gourmet restaurant

  Baby food company

  Nutritional products company

-.6

3.8

Compute the coefficient of variation for each of the four companies. (Round your answers to 2 decimal places.)

  Treynor Pie Company

  Nutritional products company

Which company is the least risky?

(a-3)

Which company is the most risky?

Which of the acquisition candidates is most likely to reduce Treynor Pie Company’s risk?

Transoceanic Airlines is examining a resort motel chain to add to its operation. Prior to the acquisition, the normal expected outcomes for the firm are as follows:

Outcomes ($ millions)

  Recession

  Normal economy

  Strong economy

Compute the expected value, standard deviation, and coefficient of variation. (Enter your answer in millions. Round Standard deviation to 2 decimal places and final answer to 3 decimal places.Omit the “$” sign in your response.)

  Expected value

  Standard deviation

  Coefficient of variation

Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products, Inc., as vice president of finance.

     She believes in adjusting projects for risk. Her father is somewhat skeptical but agrees to go along with her. Her approach is somewhat different than the risk-adjusted discount rate approach, but achieves the same objective.

     She suggests that the inflows for each year of a project be adjusted downward for lack of certainty and then be discounted back at a risk-free rate. The theory is that the adjustment penalty makes the inflows the equivalent of riskless inflows, and therefore a risk-free rate is justified.

     A table showing the possible coefficient of variation for an inflow and the associated adjustment factor is shown below:

Adjustment factor

.90

.80

.70

1.25

    Assume a $180,000 project provides the following inflows with the associated coefficients of variation for each year.

Inflow

31,800

.15  

53,200

.23  

77,000

.52  

.71  

66,100

1.10  

Fill in the table below (Round “Adjustment factor” to 2 decimal places. Omit the “$” sign in your response):

Adjusted Inflow

If the risk-free rate is 5 percent, compute the net present value of the adjusted inflows. Use Appendix B. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest whole dollar amount. Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)

Should this project be accepted?

A

ssume a corporation has earnings before depreciation and taxes of

$

12

3

,000 depreciation of $

4

1,000 and is in a 3

5

percent tax bracket.

(a)

How much would cash flow be if there were only $21,000 in depreciation? All other factors are the same.(Omit the “$” sign in your response.)

(b)

How much cash flow is lost due to the reduced depreciation between $41,000 and $21,000? (Omit the “$” sign in your response.)

Assume a firm has earnings before depreciation and taxes of $

6

50

,000 and no depreciation. It is in a
40 percent tax bracket.

Compute its cash flow. (Omit the “$” sign in your response.)

  Cash flow

Assume it has $

65

0,000 in depreciation. Recompute its cash flow. (Omit the “$” sign in your response.)

(c)

How large a cash flow benefit did the depreciation provide? (Omit the “$” sign in your response.)

  Benefit in cash flow

If the firm is in a

35

percent tax bracket, compute its cash flow. (Omit the “$” sign in your response.)

If it is in a

20

percent tax bracket, compute its cash flow. (Omit the “$” sign in your response.)

Assume a $2

9

0,000

investment and the following cash flows for two products:

Year

Product X

Product Y

10

0,000

7

5,000

80,000

40,000

Calculate the payback for products X and Y. (Round your answers to 2 decimal places.)

Payback period

  Product X

 years

  Product Y

Which alternative would you select under the payback method?

Product X

Product Y

The Short-Line Railroad is considering a $

140

,000 investment in either of two companies. The cash flows are as follows:

E

lectric Co.

Water Works

85

,000  

30,000  

25,000  

4

–

10

10,000  

Compute the payback period for both companies. (Round your answers to 1 decimal place.)

  Electric Co.

 years  

  Water Works

Which of the investments is superior from the information provided?

D

iaz Camera

Company

is considering two investments, both of which cost  $1

4,000

. The cash flows are as follows:

Use 
Appendix B
.

Project

A

Project B

8,000

7,000

6,000

9,000

(a-1)

Calculate the payback period for project A and project B. (Round your answers to 2 decimal places.)

Payback period     

  Project A

  Project B

 years  

(a-2)

Which of the two projects should be chosen based on the payback method?

Project A

Project B

(b-1)

Calculate the net present value for project A and project B. Assume a cost of capital of 8 percent.(Round “PV

F

actor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Omit the “$” sign in your response.)

(b-2)

Which of the two projects should be chosen based on the net present value method?

Project B

Project A

  (c)

Should a firm normally have more confidence in answer derived based on Net present value method or Payback method?

Net present value method

Payback method

You buy a new piece of equipment for $22,816, and you receive a cash inflow of $3,100 per year for 10 years. Use 
Appendix D
.

What is the internal rate of return? (Round “PV Factor” to 3 decimal places. Round your answer to the nearest whole percent. Omit the “

%

” sign in your response.)

  Internal rate of return

 %  

Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $52,000. The annual cash inflows for the next three years will be:

26,000

24,000

19,000

Determine the internal rate of return using interpolation. Use 
Appendix D
. (Round “PV Factor” and intermediate to 3 decimal places. Round final answer to 2 decimal places. Omit the “%” sign in your response.)

 %  

With a cost of capital of 14 percent, should the machine be purchased?

  Net present value

Turner Video will invest $66,500 in a project. The firm’s cost of capital is 12 percent. The investment will provide the following inflows. Use Appendix A.

Inflow

$ 19,000  

29,000  

33,000  

If the reinvestment assumption of the net present value method is used, what will be the total value of the inflows after five years? (Assume the inflows come at the end of each year.) (Round “FV Factor” to 3 decimal places, intermediate and final answers to the nearest whole dollar amount.Omit the “$” sign in your response.)

  Total value of inflows

If the firm is able to earn 13 percent on reinvested funds, what will be the total value of the inflows after five years? (Round “FV Factor” to 3 decimal places, intermediate and final answers to the nearest whole dollar amount.Omit the “$” sign in your response.)

Which investment assumption is better?

Reinvestment assumption of IRR

Reinvestment assumption of NPV

The Suboptimal

G

lass Company uses a process of capital rationing in its decision making. The firm’s cost of capital is 10 percent. It will only invest $80,600 this year. It has determined the internal rate of return for each of the following projects.

Project size

Internal rate
of return

11,400

20%

31,400

22   

26,400

12  

14   

16  

21,400

19   

16,400

17   

Pick out the projects that the firm should accept. (You may select more than one answer. Click the box with a check mark for the correct answer and click to empty the box for the wrong answer.)

Project E

If

Projects

A and B are mutually exclusive, which projects would you accept in spending $80,600? (You may select more than one answer. Click the box with a check mark for the correct answer and click to empty the box for the wrong answer.)

Project E

Project A

Project F

Project C

Project B

Project D

Project G

Ke

ller Construction is considering two new investments. Project E calls for the purchase of earth moving equipment.

Project H

represents an investment in a hydraulic lift. Keller wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows: Use 
Appendix B
.

($35,000 investment)

($

37,000

investment)

$ 8,000    

$

19,000    

13,000    

16,000    

15,000    

21,000    

Determine the net present value of the projects based on a zero discount rate. (Omit the “$” sign in your response.)

  Project E

 $   

  Project H

Determine the net present value of the projects based on a 13 percent discount rate. (Round “PV Factors” to 3 decimal places and final answer to the nearest dollar amount. Omit the “$” sign in your response.)

(d)

If the two projects are not mutually exclusive, what would your acceptance or rejection decision be if the cost of capital (discount rate) is 8 percent? (Use the net present value profile for your decision; no actual numbers are necessary.)

Telstar Communications is going to purchase an asset for $720,000 that will produce $350,000 per year for the next four years in earnings before depreciation and taxes. The asset will be depreciated using the three-year MACRS depreciation schedule in Use Table 12–9. (This represents four years of depreciation based on the half-year convention.) The firm is in a 35 percent tax bracket.

Fill in the schedule below for the next four years. (Round “Percentage depreciation” to 3 decimal places. Round all dollar values to the nearest whole number. Input all amounts as positive values. Omit the “$” sign in your response.)

  Earnings before depreciation and taxes

  Depreciation

  Earnings before taxes

  Taxes

  Earnings after taxes

+

Depreciation

The Summitt Petroleum Corporation will purchase an asset that qualifies for three-year MACRS depreciation. The cost is $390,000 and the asset will provide the following stream of earnings before depreciation and taxes for the next four years: Use Table 12-9.

Year 1

206

,000  

Year 2

2

54

,000  

Year 3

86,000  

Year 4

78,000  

The firm is in a 40 percent tax bracket and has an 12 percent cost of capital. Use Appendix B

Calculate the net present value. (Round “PV Factor” to 3 decimal places, intermediate calculations and final answer to the nearest whole dollar amount. Omit the “$” sign in your response.)

An asset was purchased three years ago for $1

95

,000. It falls into the five-year category for MACRS depreciation. The firm is in a 30 percent tax bracket. Use Table 12–9.

Compute the tax loss on the sale and the related tax benefit if the asset is sold now for $22,560.(Round “Percentage depreciation” to 3 decimal places. Input all amounts as positive values. Omit the “$” sign in your response.)

  Tax loss

on the sale

  Tax benefit

Compute the gain and related tax on the sale if the asset is sold now for $71,060. (Round “Percentage depreciation” to 3 decimal places. Input all amounts as positive values. Omit the “$” sign in your response.)

  Taxable gain

  Tax obligation

DataPoint Engineering is considering the purchase of a new piece of equipment for $390,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $210,000 in nondepreciable working capital. Seventy two thousand five hundred dollars of this investment will be recovered after the sixth year and will provide additional cash flow for that year. Income before depreciation and taxes for the next six years will be: Use 
Table 12–9
 and 
Appendix B
.

Amount

230,000

190,000

1

45

,000

110

,000

 100,000

The tax rate is 40 percent. The cost of capital must be computed based on the following:

Cost
(aftertax)

Weights

  Debt

Kd

9

.2

0

  Preferred stock

Kp

1

3.8

0

  Common equity
  (retained earnings)

18.00

Determine the annual depreciation schedule. (Round “Percentage depreciation” to 3 decimal places. Round all dollar values to the nearest whole number. Omit the “$” sign in your response.)

Depreciation
base

Percentage
depreciation

Annual
depreciation

Determine annual cash flow. Include recovered working capital in the sixth year. (Round all dollar values to the nearest whole number. Omit the “$” sign in your response.)

Determine the weighted average cost of capital. (Round your intermediate calculations and final answer to 2 decimal places. Omit the “%” sign in your response.)

  Weighted average cost of capital

Determine the net present value. (Round “PV Factor” to 3 decimal places. Round your intermediate and final answer to the nearest whole number. Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)

(e)

Should DataPoint purchase the new equipment?

Hercules Exercising Equipment Co. purchased a computerized measuring device two years ago for $86,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $38,800.

        A new piece of equipment will cost $270,000. It also falls into the five-year category for MACRS depreciation.

        Assume the new equipment would provide the following stream of added cost savings for the next six years. Use Table 12–9 and Appendix B.

$65,000  

55,000  

53,000

51,000

48,000

37,000  

The firm’s tax rate is 30 percent and the cost of capital is 11 percent.

What is the book value of the old equipment? (Round “Percentage depreciation” to 3 decimal places. Omit the “$” sign in your response.)

  Book value

What is the tax loss on the sale of the old equipment? (Omit the “$” sign in your response.)

What is the tax benefit from the sale? (Omit the “$” sign in your response.)

What is the cash inflow from the sale of the old equipment? (Omit the “$” sign in your response.)

Cash inflow

What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.)(Omit the “$” sign in your response.)

  Net cost

(f)

Determine the depreciation schedule for the new equipment. (Round “Percentage depreciation” to 3 decimal places. Omit the “$” sign in your response.)

(g)

Determine the depreciation schedule for the remaining years of the old equipment. (Round “Percentage depreciation” to 3 decimal places. Omit the “$” sign in your response.)

$    

(h)

Determine the incremental depreciation between the old and new equipment and the related tax shield benefits. (Round all dollar values to the nearest whole number. Round “Tax rate” to 2 decimal places. Omit the “$” sign in your response.)

    Depreciation
   on new
   equipment

    Depreciation
   on old
   equipment

    Incremental
   depreciation

    Tax rate

  Tax shield
 benefits

(i)

Compute the aftertax benefits of the cost savings. (Round “Tax rate” to 2 decimal places. Omit the “$” sign in your response.)

Savings

    (1

−

Tax rate)

After tax
savings

(j)

Add the depreciation tax shield benefits and the aftertax cost savings, and determine the present value.(Round “PV Factor” to 3 decimal places. Round your intermediate and final answers to the nearest whole dollar amount. Omit the “$” sign in your response.)

Tax shield
benefits from
depreciation

After tax
cost savings

Total annual
benefits

Present value

(k)

Compare the present value of the incremental benefits (j) to the net cost of the new equipment (e).(Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)

(l)

Should the replacement be undertaken?

No

Yes

Assume you are risk-averse and have the following three choices.

Expected
value

Standard
deviation

2,010

1,700

2,420

2,260

2,

180

1,

34

0

Compute the coefficient of variation for each. (Round your answers to 2 decimal places.)

Coefficient of variation

Which project will you select?

Project A

Project B

Project C

Lowe Technology Corp. is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given.

Possible
market reaction

Sales in
units

Probabilities

  Low

response

.3

0

  Moderate

response

.20

  High response

  Very high response

What is the expected value of unit sales for the new product? (Round your answer to 2 decimal places.)

  Expected value

What is the standard deviation of unit sales? (Round your final answer to 2 decimal places.)

Standard deviation

Shack Homebuilders, Limited, is evaluating a new promotional campaign that could increase home sales.

Possible outcomes

and probabilities of the outcomes are shown below.

Additional
sales in units

  Ineffective campaign

.4

0

  Normal response

  Extremely effective

Compute the coefficient of variation. (Round your answer to 3 decimal places.)

  Coefficient of variation

Five investment alternatives have the following returns and standard deviations of returns.

Alternatives

Returns: Expected value

1,280

1,

150

1,790

1,490

12,300

2,200

1,310

1,350

65,400

19,400

Calculate the coefficient of variation and rank the five alternatives from lowest risk to the highest risk by using the coefficient of variation. (Round your answers to 2 decimal places.)

Coefficient of
variation

Rank

Sensor Technology wishes to determine its coefficient of variation as a company over time. The firm projects the following data (in millions of dollars):

Profits:
Expected value

93

157

98

226

Compute the coefficient of variation (V) for each time period. (Round your answers to 2 decimal places.)

Does the risk (V) appear to be increasing over a period of time?

(b) 

Kyle’s Shoe Stores, Inc., is considering opening an additional suburban outlet. An aftertax expected cash flow of $100 per week is anticipated from two stores that are being evaluated. Both stores have positive net present values.

  Site A

Probability

Cash flows

.25

  Site B

.10

Compute the coefficient of variation for each site. (Do not round intermediate calculations. Round your answers to 4 decimal places.)

Which store site would you select based on the distribution of these cash flows? Use the coefficient of variation as your measure of risk.

Site A

Site B

Micro Systems is evaluating a $

59,100

project with the following cash flows.

Years

9,180

13,100

21,700

25,600

The coefficient of variation for the project is .654.

Discount rate

.26

.5

0

.51

.

75

.76

1.01

− 

1.2

5

Select the appropriate discount rate.

7%

11%

15%

17%

20%

Compute the net present value. Use Appendix B
. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Negative amount should be indicated by a minus sign.  Omit the “$” sign in your response.)

Based on the net present value should the project be undertaken?

Fill in the table below from Appendix B. (Round your answers to 3 decimal places.)

10%

18%

What is the impact of a high discount rate on long-term inflows?

Greater on long-term value

Lesser on long-term value

Debby’s Dance Studios is considering the purchase of new sound equipment that will enhance the popularity of its aerobics dancing. The equipment will cost $22,400. Debby is not sure how many members the new equipment will attract, but she estimates that her increased annual cash flows for each of the next five years will have the following probability distribution. Debby’s cost of capital is 12 percent.

3,890

.3  

5,330

.2  

8,390

9,880

What is the expected value of the cash flow? (Omit the “$” sign in your response.)

  Expected cash flow

What is the expected net present value? Use Appendix D. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)

Should Debby buy the new equipment?

Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,

63

0,000 and will produce $306,000 per year in years 5 through 15 and $572,000 per year in years 16 through 25. The U.S. gold mine will cost $2,012,000 and will produce $270,000 per year for the next 25 years. The cost of capital is 10 percent.

Calculate the net present value for each project. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Omit the “$” sign in your response.)

  The Australian Mine

  The U.S. Mine

Which investment should be made?

Australian Mine

U.S. Mine

If the Australian Mine justifies an extra 1 percent premium over the normal cost of capital because of its riskiness and the relative uncertainty of cash flows, recalculate the net present value of the mine.(Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest dollar amount. Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)

Does the investment decision change?

Mr. Sam Golff desires to invest a portion of his assets in rental property. He has narrowed his choices down to two apartment complexes, Palmer Heights and Crenshaw Village. After conferring with the present owners, Mr. Golff has developed the following estimates of the cash flows for these properties.

  Palmer Heights

Yearly aftertax
cash inflow
(in thousands)

$ 90

125

130

  Crenshaw Village

$ 95

Mr. Golff is likely to hold the complex of his choice for 30 years, and he will use this time period for decision-making purposes. Either apartment complex can be acquired for $206,000. Mr. Golff uses a risk-adjusted discount rate when considering investments. His scale is related to the coefficient of variation.

0.20

5  

0.21

0.40

8  

(cost of capital)

0.41

0.60

    Over 0.60

(a) 

Compute the risk-adjusted net present values for Palmer Heights and Crenshaw Village. (Omit the “$” sign in your response.)

Which investment should Mr. Golff accept if the two investments are mutually exclusive?

Crenshaw Village

Palmer Heights

Both

None

Which investment should Mr. Golff accept If the investments are not mutually exclusive and no capital rationing is involved?

Palmer Heights

Crenshaw Village

Both

None

Allison’s Dresswear Manufacturers is preparing a strategy for the fall season. One alternative is to expand its traditional ensemble of wool sweaters. A second option would be to enter the cashmere sweater market with a new line of high-quality designer label products. The marketing department has determined that the wool and cashmere sweater lines offer the following probability of outcomes and related cash flows.

EXPAND WOOL SWEATERS LINE

ENTER CASHMERE SWEATERS LINE

Expected sales

Present value
of cash flows
from sales

  Fantastic

262,000

378,000

194,000

239,000

88,100

The initial cost to expand the wool sweater line is $161,000. To enter the cashmere sweater line the initial cost in designs, inventory, and equipment is $136,000.

Calculate Net present value. (Negative amounts should be indicated by a minus sign. Omit the “$” sign in your response.)

  Expand wool sweaters line

  Enter cashmere sweaters line

When returns from a project can be assumed to be normally distributed (represented by a symmetrical, bell-shaped curve), the areas under the curve can be determined from statistical tables based on standard deviations. For example, 68.26 percent of the distribution will fall within one standard deviation of the expected value (     ± 1σ). Similarly 95.44 percent will fall within two standard deviations (      ± 2σ), and so on. An abbreviated table of areas under the normal curve is shown here.

Assume Project A has an expected value of $34,000 and a standard deviation ( σ ) of $6,800.

What is the probability that the outcome will be between $23,800 and $44,200? (Round your answer to 4 decimal places.)

  Probability

What is the probability that the outcome will be between $20,400 and $47,600? (Round your answer to 4 decimal places.)

What is the probability that the outcome will be at least $20,400? (Round your answer to 4 decimal places.)

What is the probability that the outcome will be less than $45,920? (Round your answer to 4 decimal places.)

What is the probability that the outcome will be less than $30,600 or greater than $40,800? (Round your answer to 4 decimal places.)

The Oklahoma Pipeline Company projects the following pattern of inflows from an investment. The inflows are spread over time to reflect delayed benefits. Each year is independent of the others.

Year 5

Year 10

.40  

.35  

.20  

.30  

The expected value for all three years is $60.

Compute the standard deviation for each of the three years. (Round your answers to 2 decimal places.)

  Year 1

  Year 5

  Year 10

Treynor Pie Co. is a food company specializing in high-calorie snack foods. It is seeking to diversify its food business and lower its risks. It is examining three companies—a gourmet restaurant chain, a baby food company, and a nutritional products firm. Each of these companies can be bought at the same multiple of earnings. The following represents information about the companies.

Correlation with
Treynor Pie
company

Sales
($ millions)

Expected earnings($ millions)

Standard deviation
in earnings
($ millions)

  Treynor Pie Company

182

  Gourmet restaurant

  Baby food company

  Nutritional products company

-.6

Compute the coefficient of variation for each of the four companies. (Round your answers to 2 decimal places.)

  Treynor Pie Company

  Nutritional products company

Which company is the least risky?

Gourmet restaurant

Baby food company

Nutritional products company

Treynor Pie Company

(a-3)

Which company is the most risky?

Baby food company

Gourmet restaurant

Nutritional products company

Treynor Pie Company

Which of the acquisition candidates is most likely to reduce Treynor Pie Company’s risk?

Nutritional products company

Gourmet restaurant

Baby food company

Transoceanic Airlines is examining a resort motel chain to add to its operation. Prior to the acquisition, the normal expected outcomes for the firm are as follows:

Outcomes
($ millions)

  Recession

  Normal economy

  Strong economy

Compute the expected value, standard deviation, and coefficient of variation. (Enter your answer in millions. Round Standard deviation to 2 decimal places and final answer to 3 decimal places.Omit the “$” sign in your response.)

Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products, Inc., as vice president of finance.

     She believes in adjusting projects for risk. Her father is somewhat skeptical but agrees to go along with her. Her approach is somewhat different than the risk-adjusted discount rate approach, but achieves the same objective.

     She suggests that the inflows for each year of a project be adjusted downward for lack of certainty and then be discounted back at a risk-free rate. The theory is that the adjustment penalty makes the inflows the equivalent of riskless inflows, and therefore a risk-free rate is justified.

     A table showing the possible coefficient of variation for an inflow and the associated adjustment factor is shown below:

Adjustment
factor

.90

.80

.70

    Assume a $180,000 project provides the following inflows with the associated coefficients of variation for each year.

31,800

.15  

53,200

.23  

77,000

.52  

.71  

66,100

1.10  

Fill in the table below (Round “

Adjustment factor

” to 2 decimal places. Omit the “$” sign in your response):

Adjusted Inflow

If the risk-free rate is 5 percent, compute the net present value of the adjusted inflows. Use Appendix B
. (Round “PV Factor” to 3 decimal places, intermediate and final answers to the nearest whole dollar amount. Negative amount should be indicated by a minus sign. Omit the “$” sign in your response.)

Should this project be accepted?