Grand Canyon FIn450 module 2 assignment problems-p 12-3 12-4 12-8 12-12 12-14 and 12-18

P 12-3

Breakeven cash inflows and risk Blair Gasses and Chemicals is a supplier of highly

purified gases to semiconductor manufacturers. A large chip producer has asked Blair

to build a new gas production facility close to an existing semiconductor plant. Once

the new gas plant is in place, Blair will be the exclusive supplier for that semiconductor

fabrication plant for the subsequent 5 years. Blair is considering one of two plant

designs. The first is Blair’s “standard” plant, which will cost $30 million to build. The

second is for a “custom” plant, which will cost $40 million to build. The custom plant

will allow Blair to produce the highly specialized gases that are required for an emerging

semiconductor manufacturing process. Blair estimates that its client will order

$10 million of product per year if the traditional plant is constructed, but if the customized

design is put in place, Blair expects to sell $15 million worth of product annually

to its client. Blair has enough money to build either type of plant, and, in the absence

of risk differences, accepts the project with the highest NPV. The cost of capital is 12%.

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

b. Find the breakeven cash inflow for each project.

c. The firm has estimated the probabilities of achieving various ranges of cash inflows

for the two projects as shown in the following table. What is the probability

that each project will achieve at least the breakeven cash inflow found in part b?

d. Which project is more risky? Which project has the potentially higher NPV?

Discuss the risk–return trade-offs of the two projects.

e. If the firm wished to minimize losses (that is, NPV 6 $0), which project would

you recommend? Which would you recommend if the goal were to achieve a

higher NPV?

b. Assume that the firm’s cost of capital is 10% and that both projects have 20-year

lives. Construct a table similar to this one for the NPVs for each project. Include

the range of NPVs for each project.

Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in

one of three mutually exclusive projects, E, F, and G. The firm’s cost of capital, r, is

15%, and the risk-free rate, RF, is 10%. The firm has gathered the basic cash flow

and risk index data for each project as shown in the following table.

a. Find the net present value (NPV) of each project using the firm’s cost of capital.

Which project is preferred in this situation?

b. The firm uses the following equation to determine the risk-adjusted discount

c. Use the RADR for each project to determine its risk-adjusted NPV. Which project

is preferable in this situation?

d. Compare and discuss your findings in parts a and c. Which project do you recommend

that the firm accept?

Risk classes and RADR Moses Manufacturing is attempting to select the best of

three mutually exclusive projects, X, Y, and Z. Although all the projects have 5-year

lives, they possess differing degrees of risk. Project X is in class V, the highest-risk

class; project Y is in class II, the below-average-risk class; and project Z is in class

III, the average-risk class. The basic cash flow data for each project and the risk

classes and risk-adjusted discount rates (RADRs) used by the firm are shown in the

following tables.

b. Which project, if any, would you recommend that the firm undertake?

Unequal lives: ANPV approach Portland Products is considering the purchase of

one of three mutually exclusive projects for increasing production efficiency. The

firm plans to use a 14% cost of capital to evaluate these equal-risk projects. The initial

investment and annual cash inflows over the life of each project are shown in the

following table.

a. Calculate the NPV for each project over its life. Rank the projects in descending

order on the basis of NPV.

b. Use the annualized net present value (ANPV) approach to evaluate and rank the

projects in descending order on the basis of ANPV.

c. Compare and contrast your findings in parts a and b. Which project would you

recommend that the firm purchase? Why?

Capital rationing: IRR and NPV approaches Valley Corporation is attempting to select

the best of a group of independent projects competing for the firm’s fixed capital

budget of $4.5 million. The firm recognizes that any unused portion of this budget

will earn less than its 15% cost of capital, thereby resulting in a present value of inflows

that is less than the initial investment. The firm has summarized, in the following

table, the key data to be used in selecting the best group of projects.

b. Use the net present value (NPV) approach to select the best group of projects.

c. Compare, contrast, and discuss your findings in parts a and b.

d. Which projects should the firm implement? Why?