Principles of Managerial Finance

b. Use NPV to evaluate the projects, using risk-adjusted discount rates (RADRs)

to account for risk.

c. Compare, contrast, and explain your findings in parts aand b.

PROBLEMS

10–1 Recognizing risk Caradine Corp., a media services firm with net earnings of

$3,200,000 in the last year, is considering several projects.

The media services business is cyclical and highly competitive. The board of

directors has asked you, as chief financial officer, to

a. Evaluate the risk of each proposed project and rank it “low,” “medium,” or

“high.”

b. Comment on why you chose each ranking.

10–2 Breakeven cash inflows Etsitty Arts, Inc., a leading producer of fine cast silver

jewelry, is considering the purchase of new casting equipment that will allow it

to expand the product line into award plaques. The proposed initial investment

is $35,000. The company expects that the equipment will produce steady income

throughout its 12-year life.

a. If Etsitty requires a 14% return on its investment, what minimum yearly cash

inflow will be necessary for the company to go forward with this project?

b. How would the minimum yearly cash inflow change if the company required

a 10% return on its investment?

10–3 Breakeven cash inflows and risk Pueblo Enterprises is considering investing in

either of two mutually exclusive projects, X and Y. Project X requires an initial

investment of $30,000; project Y requires $40,000. Each project’s cash inflows

are 5-year annuities; project X’s inflows are $10,000 per year; project Y’s are

$15,000. The firm has unlimited funds and, in the absence of risk differences,

accepts the project with the highest NPV. The cost of capital is 15%.

a. Find the NPV for each project. Are the projects acceptable?

b. Find the breakeven cash inflowfor each project.

Project Initial Investment Details

A $ 35,000 Replace existing office furnishings.

B 500,000 Purchase digital film-editing equipment for use with

several existing accounts.

C 450,000 Develop proposal to bid for a $2,000,000 per year

10-year contract with the U.S. Navy, not now an

account.

D 685,000 Purchase the exclusive rights to market a quality

educational television program in syndication to local

markets in the European Union, a part of the firm’s

existing business activities.

CHAPTER 10 Risk and Refinements in Capital Budgeting 453

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