Principles of Managerial Finance

table of estimates of annual cash inflows for pessimistic, most likely, and opti-

mistic results.

a. Determine the range of annual cash inflows for each of the two computers.

b. Construct a table similar to this for the NPVs associated with each outcome

for both computers.

c. Find the range of NPVs, and subjectively compare the risks associated with

purchasing these computers.

10–6 Simulation Ogden Corporation has compiled the following information on a

capital expenditure proposal:

(1) The projected cash inflowsare normally distributed with a mean of $36,000

and a standard deviation of $9,000.

(2) The projected cash outflowsare normally distributed with a mean of

$30,000 and a standard deviation of $6,000.

(3) The firm has an 11% cost of capital.

(4) The probability distributions of cash inflows and cash outflows are not

expected to change over the project’s 10-year life.

a. Describe how the foregoing data can be used to develop a simulation model

for finding the net present value of the project.

b. Discuss the advantages of using a simulation to evaluate the proposed

project.

10–7 Risk-adjusted discount rates—Basic Country Wallpapers is considering invest-

ing in one of three mutually exclusive projects, E, F, and G. The firm’s cost of

capital, k, is 15%, and the risk-free rate, RF, is 10%. The firm has gathered the

following basic cash flow and risk index data for each project.

Project (j)

EF G

Initial investment (CF 0 ) $15,000 $11,000 $19,000

Year (t) Cash inflows (CFt)

1 $ 6,000 $ 6,000 $ 4,000

2 6,000 4,000 6,000

3 6,000 5,000 8,000

4 6,000 2,000 12,000

Risk index (RIj) 1.80 1.00 0.60

Computer P Computer Q

Initial investment (CF 0 ) $3,000 $3,000

Outcome Annual cash inflows (CF)

Pessimistic $ 500 $ 400

Most likely 750 750

Optimistic 1,000 1,200

CHAPTER 10 Risk and Refinements in Capital Budgeting 455

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