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

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

$254,894
$37,908
$303,263
$80,000

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.

jeff jeffy answered 9 months ago

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