Murdock Paints is in the process of evaluating two mutually exclusive additions
ID: 2771972 • Letter: M
Question
Murdock Paints is in the process of evaluating two mutually exclusive additions to its processing capacity. The firm’s financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows associated with each project. These estimates are shown in the following table.
Project A - Project B
Initial investment (CF0) -$8,000 -$8,000
Outcome - Annual cash inflows (CF)
Pessimistic - $ 200 $ 900
Most likely - 1,000 1,000
Optimistic - 1,800 1,100
a. Determine the range of annual cash inflows for each of the two projects.
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.
c. Do parts a and b provide consistent views of the two projects? Explain.
d. Which project do you recommend? Why?
Explanation / Answer
Pessimistic Scenario
Most Likely Scenario
Optimistic scenario
Under optimistic scenario, Project A should be accepted as it has a higher NPV
Initial Investment -8000 -8000 Years Project A Project B Present Value of A @ 10% Present Value of B @ 10% 1 200 900 181.82 818.18 2 200 900 165.29 743.80 3 200 900 150.26 676.18 4 200 900 136.60 614.71 5 200 900 124.18 558.83 6 200 900 112.89 508.03 7 200 900 102.63 461.84 8 200 900 93.30 419.86 9 200 900 84.82 381.69 10 200 900 77.11 346.99 11 200 900 70.10 315.44 12 200 900 63.73 286.77 13 200 900 57.93 260.70 14 200 900 52.67 237.00 15 200 900 47.88 215.45 16 200 900 43.53 195.87 17 200 900 39.57 178.06 18 200 900 35.97 161.87 19 200 900 32.70 147.16 20 200 900 29.73 133.78 Total 1702.71 7662.21 NPV -6297.29 -337.79Related Questions
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