riskSDEDInc.
Problem 1
Recognizing riskSDEDInc., a public relations firm with net earnings of $3,200,000 in the last year, is considering several projects.
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.
The PR business is cyclical and highly competitive. The board of directors has asked you, as chief financial officer, to do the following:
1. Evaluate the risk of each proposed project and rank it “low,” “medium,” or “high.”
2. Comment on why you chose each ranking.
Problem 2
Basic scenario analysisLee’s Feed is in the process of evaluating two mutually exclusive additions to its processing capacity. The firm’s financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows associated with each project. These estimates are shown in the table on page 488.
Project A Project B
Initial investment (CF0) $8,000 $8,000
Outcome Annual cash inflows ( CF )
Pessimistic $ 200 $ 900
Most likely 1,000 1,000
Optimistic 1,800 1,100
1. Determine the range of annual cash inflows for each of the two projects.
2. Assume that the firm’ s cost of capital is 10% and that both projects have 20-year lives. Construct a table similar to this for the NPVs for each project. Include the range of NPVs for each project.
3. Do parts a andb provide consistent views of the two projects? Explain.
4. Which project do you recommend? Why?
Problem 3
Scenario analysisCompudyne Services is considering the purchase of one of two new personal computers, P and Q. The company expects both to provide benefits over a 10-year period, and each has a required investment of $3,000. The firm uses a 10% cost of capital. Management has constructed the following table of estimates of annual cash inflows for pessimistic, most likely, and optimistic results.
Computer P Computer Q
Initial investment (CF0) $3,000 $3,000
Outcome Annual cash inflows (CF)
Pessimistic $ 500 $ 400
Most likely 750 750
Optimistic 1,000 1,200
1. Determine the range of annual cash inflows for each of the two computers.
2. Construct a table similar to this for the NPVs associated with each outcome for both computers.
3. Find the range of NPVs, and subjectively compare the risks associated with purchasing these computers.
ScholarMatic: Explanation & Answer
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