Principles of Managerial Finance

FIGURE 10.3 Calculation of NPVs for Bennett Company’s Capital Expenditure Alternatives
using RADRs
Time lines depicting the cash flows and NPV calculations using RADRs for projects A and B

CHAPTER 10 Risk and Refinements in Capital Budgeting 437

6063.13

 42000 CF 0

CF 1

I

NPV

N

14000

5

14

Solution

Input Function

9798.43

 45000 CF 0

CF 1

CF 3

N

I

NPV

CF 2

28000

12000

10000

3

11

Solution

Input Function

Project A Project B

Project A

1

$14,000

0

$42,000

48,063

k = 14%

NPVA = $ 6,063

2

$14,000

3

$14,000

4

$14,000

5

$14,000

Project B

End of Year

End of Year

1

$28,000

0

$45,000

25,225

$54,798

9,739

7,312

6,587

5,935

NPVB = $ 9,798

k = 11%

k = 11%

k = 11%

k = 11%

k = 11%

2

$12,000

3

$10,000

4

$10,000

5

$10,000

The calculated NPVs for projects A and B of $6,063 and $9,798, respectively,

agree with those shown in Figure 10.3.

Note: When we use the risk indexes of 1.6 and 1.0 for projects A and B, respectively, along with the table in the middle of the preceding page, a

risk-adjusted discount rate (RADR) of 14% results for project A and a RADR of 11% results for project B.