Making Capital Investment Decisions.

Risk Analysis, Real options

Chapter 6: CQs: 2,

a. Yes
b. Yes
c. No
d. Yes
e. No
f. Yes
g. Yes

3,

a. Yes
b. Yes
c. No

7,

The EAC approach is appropriate when comparing mutually exclusive projects with
different lives that will be replaced when they wear out. This type of analysis is
necessary so that the projects have a common life span over which they can be
compared; in effect, each project is assumed to exist over an infinite horizon of N-year
repeating projects. Assuming that this type of analysis is valid implies that the project cash
flows remain the same forever, thus ignoring the possible effects of, among other things:
(1) inflation, (2) changing economic conditions, (3) the increasing unreliability of cash flow
estimates that occur far into the future, and (4) the possible effects of future technology
improvement that could alter the project cash flows.

Q&Ps: 1,

OCF = (Sales − Costs)(1 −TC) + TCDepreciation

OCF = [($4.95 × 1,400) − ($1.97 × 1,400)](1 − .21) + .21($9,300/5)

OCF = $3,686.48

So, the NPV of the project is:

NPV = −$9,300 + $3,686.48(PVIFA14%,5)
NPV = -$9,300 + 3,686.48/1.14 + 3,686.48/1.14^2 + 3,686.48/1.14^3 + 3,686.48/1.14^4
+ 3,686.48/1.14^5
NPV = $3,355.98

2,
6,

10,
OCF = −$54,000(1 − .30) + .30($213,000 / 3)
OCF = −$16,500

NPV = −$213,000 − $16,500(PVIFA9%,3) + ($21,700 / 1.093)

NPV = −$238,009.98

EAC = −$238,009.98 / (PVIFA9%,3)

EAC = −$94,026.98

And the OCF and NPV for Techron II is:

OCF = −$27,000(1 − .30) + .30($375,000 / 5)

OCF = $3,600

NPV = −$375,000 + $3,600(PVIFA9%,5) + ($21,700 / 1.095)

NPV = −$346,893.74

EAC = −$346,893.74 / (PVIFA9%,5)

EAC = −$89,183.77
15,
21,

30,

Chapter 7: Q&Ps: 6,
7,

17,

18,

19,