Question

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 Crest		Hillcrest Apartments
$40,000	0.2	$15,000	0.2
55,000	0.2	20,000	0.3
60,000	0.2	30,000	0.4
75,000	0.2	40,000	0.1
50,000	0.2

Mr. is likely to hold the apartment complex of his choice for about 25 years and will use this period for decision making purposes. Either apartment can be purchased for $140,000. Mr. Backster uses 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	15%
Over 0.50	not considered

a) compute the risk-adjusted net present value for Windy Acres and Hillcrest Apartments.

b) Which investment should Mr. Backster accept if the two investments are mutually exclusive? If the investments are not mutually exclusive and no capital rationing is involved, how would your decision be affected?

Answer 1