Galaxy Satellite Co.
is attempting to select the best group of independent projects competing for
the firm’s fixed capital budget of $10,000,000. Any unused portion of this budget will earn less
than its 20 percent cost of capital. A summary of key data about the proposed projects follows.
Table 9.7
Project
Initial Investment
IRR PV of Inflows at 20%
A $3,000,000 21% $3,050,000
B 9,000,000 25 9,320,000
C 1,000,000 24 1,060,000
D 7,000,000 23 7,350,000
7. Use the NPV approach to select the best group of projects. (See Table 9.7)
8. Use the IRR approach to select the best group of projects. (See Table 9.7)
9. Which projects should the firm implement? (See Table 9.7)
10. Consider the following projects, X and Y where the firm can only choose one. Project X
costs $600 and has cash flows of $400 in each of the next 2 years. Project B also costs $600, and
generates cash flows of $500 and $275 for the next 2 years, respectively. Sketch a net present
value profile for each of these projects. Which project should the firm choose if the cost of capital
is 10 percent? What if the cost of capital is 25 percent? Show all work.
11. Tangshan Mining Company is considering investing in a new mining project. The firm’s
cost of capital is 12 percent and the project is expected to have an initial after tax cost of
$5,000,000. Furthermore, the project is expected to provide after-tax operating cash flows of
$2,500,000 in year 1, $2,300,000 in year 2, $2,200,000 in year 3 and ($1,300,000) in year 4?
(a) Calculate the project’s NPV.
(b) Calculate the project’s IRR.
(c) Should the firm make the investment?
Johnson Farm Implement is faced with two mutually exclusive projects, P and Q. The following
are the data about the two projects.
Table 10.5
Project P Q
Initial Investment $40,000 $50,000
Project Life 3 years 3 years
Annual Cash Flow $15,000 $25,000
Risk Adjusted Discount Rate 10% 14%
Risk-Free Rate of Return 6% 6%
1. Evaluate the projects using risk-adjusted discount rates. (See Table 10.5.)
2. Which project do you recommend? (See Table 10.5.)
A firm is evaluating two mutually exclusive projects that have unequal lives. The firm must
evaluate the projects using the annualized net present value approach and recommend which
project they should select. The firm’s cost of capital has been determined to be 18 percent, and
the projects have the following initial investments and cash flows:
Project W Project Y
Initial investment: $40,000 $58,000
Cash flows: 1 $20,000 $30,000
2 20,000 35,000
3 20,000 40,000
4 20,000
5 20,000
Nico Manufacturing is considering investment in one of two mutually exclusive projects X and Y
which are described below. Nico Manufacturing’s overall cost of capital is 15 percent, the market
return is 15 percent and the risk-free rate is 5 percent. Nico estimates that the beta for project X is
1.20 and the beta for project Y is 1.40.
Table 10.6
Project X Project Y
Initial Investment $3,500,000 $3,900,000
Year Cash Inflows (CF)
1 $1,500,000 $1,100,000
2 1,500,000 1,600,000
3 1,500,000 1,900,000
4 1,500,000 2,300,000
1. Calculate the risk-adjusted discount rates for project X and project Y. (See Table 10.6)
2. Using the risk-adjusted discount rate method of project evaluation, find the NPV for
projects X and Y. Which project should Nico select using this method? (See Table 10.6)
3. Calculate the NPV of projects X and Y assuming that the firm did not employ the RADR
method and instead used the firm’s overall cost of capital to evaluate projects X and Y. (See Table
10.6)
7. What potential biases exist in project selection if Nico Manufacturing did not adjust for the
difference in risk between projects X and Y (See Table 10.6).
