Question

In: Finance

A corporation is assessing the risk of two capital budgeting proposals. The financial analysts have developed...

  1. A corporation is assessing the risk of two capital budgeting proposals. The financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows which are given in the following table below. The firm’s cost of capital is 10 percent. If the projects have five-year lives, the range of the net present value for Project B is approximately __________.

Project A:

Project B:

Initial Investment:

Annual Cash Inflow:

Outcome:

Initial Investment:

Annual Cash Inflow:

Outcome:

$20,000

$5,000

Pessimistic

$100,000

$20,000

Pessimistic

$10,000

Most Likely

$40,000

Most Likely

$15,000

Optimistic

$100,000

Optimistic

  1. $254,894
  2. $37,908
  3. $303,263
  4. $80,000

Solutions

Expert Solution

Range of NPV = NPV@Optimistic - NPV @Pessimistic

NPV = PV of Cash Inflows - PV of Cash Outflows

NPV@Optimistic :

Year CF PVF @10% Disc CF
0 $ -1,00,000.00     1.0000 $ -1,00,000.00
1 $ 1,00,000.00     0.9091 $      90,909.09
2 $ 1,00,000.00     0.8264 $      82,644.63
3 $ 1,00,000.00     0.7513 $      75,131.48
4 $ 1,00,000.00     0.6830 $      68,301.35
5 $ 1,00,000.00     0.6209 $      62,092.13
NPV $ 2,79,078.68

NPV@Pesimistic:

Year CF PVF @10% Disc CF
0 $ -1,00,000.00     1.0000 $ -1,00,000.00
1 $      20,000.00     0.9091 $      18,181.82
2 $      20,000.00     0.8264 $      16,528.93
3 $      20,000.00     0.7513 $      15,026.30
4 $      20,000.00     0.6830 $      13,660.27
5 $      20,000.00     0.6209 $      12,418.43
NPV $    -24,184.26

Range of NPV = NPV@Optimistic - NPV @Pessimistic

= 279078.68 - (-24184.26)

= $ 303,262.94

OPtion C is correct.


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