Info

$91,131

$79,130

Investment Outlay in 2000:

$60,000

$60,000

$50,000

A. Using a 5% risk-free rate, calculate the present value of expected cash flows after tax (CFAT) for the 10-year life of project X.

B. Calculate the minimum certainty equivalent adjustment factor for each project's CFAT that would justify investment in each project.

C. Assume that the management of MacKenzie-Rabb is risk averse and uses the certainty equivalent method in decision making. Is project X as attractive or more attractive than projects Y and Z?

D. If the company would not have been willing to invest more than $60,000 in project Y nor more than $50,000 in project Z, should project X be undertaken?

ST14.1 Solution

A. Using a 5% risk-free rate, the present value of expected cash flows after tax (CFAT) for the 10-year life of project X is $77,217, calculated as follows:

Expected Cash Flows After Tax (CFAT) per Year

PV of $1 PV of CFAT

Year

Project X

at 5%

at 5%

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