In: Finance
Mr. John Backster, a retired executive, desires to invest a portion of his assets in rental property. He has narrowed his choices to two apartment complexes, Windy Acres and Hillcrest Apartments. The anticipated annual cash inflows from each are as follows:
Windy Acres |
Hillcrest Apartments |
|||
Yearly Aftertax Cash Inflow |
Probability | Yearly Aftertax Cash Inflow |
Probability | |
80,000 | 0.2 | 85,000 | 0.2 | |
85,000 | 0.2 | 90,000 | 0.3 | |
100,000 | 0.2 | 100,000 | 0.4 | |
115,000 | 0.2 | 110,000 | 0.1 | |
120,000 | 0.2 | |||
Mr. Backster is likely to hold the apartment complex of his choice for about 20 years and will use this period for decision-making purposes. Either apartment can be purchased for $180,000. Mr. Backster uses a risk-adjusted discount rate approach when evaluating investments. His scale is related to the coefficient of variation (for other types of investments, he also considers other measures).
Coefficient of Variation | Discount Rate | |
0–0.35 | 8% | |
0.35–0.40 | 12 | (cost of capital) |
0.40–0.50 | 14 | |
Over 0.50 | not considered | |
a. Compute the risk-adjusted net present value for Windy Acres and Hillcrest Apartments. (Round "PV Factor" to 3 decimal places. Enter the answers in thousands of dollars. Do not round intermediate calculations. Round the final answers to nearest whole dollar.)
Net present value | |
Windy Acres | $ |
Hillcrest Apartments | $ |
b-1. Which investment should Mr. Backster accept if the two investments are mutually exclusive?
Hillcrest
Windy Acres
Both
None
b-2. Which investment should Mr. Backster accept If the investments are not mutually exclusive and no capital rationing is involved?
Windy Acres
Hillcrest Apartments
Both
None