Wheel has two other possible investment opportunities, which are mutually exclus

Question

Wheel has two other possible investment opportunities, which are mutually exclusive, and independent of Investment A above. Both investments will cost $120,000 and have a life of 6 years. The after tax cash flows are expected to be the same over the six year life for both projects, and the probabilities for each year's after tax cash flow is given in the table below. Investment B Investment C Probability After Tax Cash Flow Probability After Tax Cash Flow 0.25 $20,000 0.30 $22,000 0.50 32,000 0.50 40,000 0.25 40,000 0.20 50,000 1.What is the expected value of each projects annual after tax cash flow? Justify your answers and identify any conflicts between the IRR and the NPV and explain why these conflicts may occur. 2.Assuming that the appropriate discount rate for projects of this risk level is 8%, what is the risk-adjusted NPV for each project? Which project, if either, should be selected? Justify your conclusions.

Explanation / Answer

Ans 1 -

Expected value of after tax cashflow for Investment B = (0.25 x 20000) + (0.5 x 32000) + (0.25 x 40000) = $31000

Expected value of after tax cashflow for Investment C = (0.3 x 22000) + (0.5 x 40000) + (0.2 x 50000) = $36600

Ans 2 -

Investment C should be selected as it has a higher NPV.

Investment B Year Expected CF Discount Present Value NPV 0 -120000 8% -$120,000.00 $23,309.27 1 31000 8% $28,703.70 2 31000 8% $26,577.50 3 31000 8% $24,608.80 4 31000 8% $22,785.93 5 31000 8% $21,098.08 6 31000 8% $19,535.26 Investment C Year Expected CF Discount Present Value NPV 0 -120000 8% -$120,000.00 $49,197.40 1 36600 8% $33,888.89 2 36600 8% $31,378.60 3 36600 8% $29,054.26 4 36600 8% $26,902.09 5 36600 8% $24,909.35 6 36600 8% $23,064.21

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