G. Cinquetti Corporation (GCC), uses a cost of capital of 10 percent to evaluate
ID: 2758314 • Letter: G
Question
G. Cinquetti Corporation (GCC), uses a cost of capital of 10 percent to evaluate average-risk projects, and it adds or subtracts 3 percentage points to evaluate projects of more or less risk. The company uses coefficient of variation (CV) to measure riskiness of the projects.
Currently, two mutually exclusive projects are under consideration by GCC. Both have a cost of $400,000 and will last 4 years. Project A has a coefficient variable (CV) of 2.30 and will produce annual end of year cash flows of $71,104. Project B, with CV 1.70 will produce cash flows of $146,411 at the end of Years 3 and 4 only.
Which project Cinquetti Corporation should accept. Please show you calculations and write a paragraph of 4 lines to explain your approach to solve this problem.
GCC classifies a project of average-risk, if project’s CV is 2.00.
Show your work step by step. Please be clean and neat.
Explain, in words, the approach that you have used to solve this problem in 5 lines.
Explanation / Answer
Project A
It has CV greater than 2.0, so discount rate would be 10%+3%=13%.
Calculation of NPV:
Year
Cash flow
PV factor 13%
PV
0
-400000
1.0000
-400000
1
71104
0.8850
62923.89381
2
71104
0.7831
55684.86177
3
71104
0.6931
49278.63874
4
71104
0.6133
43609.41481
NPV
-$188,503.19
Project B
Discount rate would be 10%-3% = 7%
Year
Cash flow
PV factor 7%
PV
0
-400000
1.0000
-400000
1
0
0.9346
0
2
0
0.8734
0
3
146411
0.8163
119514.9885
4
146411
0.7629
111696.2509
NPV
-$168,788.76
Since, NPV of both the projects is negative, none of the projects should be chosen.
Year
Cash flow
PV factor 13%
PV
0
-400000
1.0000
-400000
1
71104
0.8850
62923.89381
2
71104
0.7831
55684.86177
3
71104
0.6931
49278.63874
4
71104
0.6133
43609.41481
NPV
-$188,503.19
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