A company wants to replace a machine with a modern, more efficient model with a
ID: 2760021 • Letter: A
Question
A company wants to replace a machine with a modern, more efficient model with a longer life expectancy. The equipment requires an initial investment of $60,000 in Year 0. The expected cash flows and standard deviations are as follows:
Year
Cash Flow
Standard Deviation
1
$140,000
$15,000
2
$160,000
$50,000
3
$300,000
$100,000
4
$400,000
$120,000
The firm’s WACC is 16 percent and the risk-free rate is 6 percent. The analyst develops the following CEFs.
Certainty Equivalent Factor (CEF)
Coefficient of Variation (CV)
Year 1
Year 2
Year 3
Year 4
CV 0.30
0.95
0.92
0.89
0.85
CV 0.30
0.85
0.82
0.78
0.73
What are the project’s NPV and its CE(NPV)?
Year
Cash Flow
Standard Deviation
1
$140,000
$15,000
2
$160,000
$50,000
3
$300,000
$100,000
4
$400,000
$120,000
Explanation / Answer
Project NPV
Year Cash flow PVF(16%, nyear) Present value
1 140000 0.862 120680
2 160000 0.743 118880
3 300000 0.641 192300
4 400000 0.552 220800
$652660
Net Present value = ppresent value of cash inflow - present value of cash outflow
=652660 - 60000
= 592660
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.