The Spinning Politician Company is considering three mutually exclusive projects
ID: 2573115 • Letter: T
Question
The Spinning Politician Company is considering three mutually exclusive projects: Adscams, Boondoggles and Closures. Project Adscams requires an initial investment of $12.000 and is expected to generate after-tax cash flows of $6,000 per year for five years. Project Boondoggles requires an initial investment of S18,000 and is expected to generate after-tax cash flows of $10,000 per year for three years. Project Closures requires an initial investment of $25,000 and is expected to generate $11,000 per year for four years. All projects can be replicated, and the initial cash outlay is net of any potential tax benefits for each. The project betas for Adscams, Boondoggles and Closures are 1.2, 0.9 and 1.5, respectively. The risk-free rate is 4.25 percent and the expected return on the market is 10.5 percent Required: a) b) c) Find the required rates of return for the three projects. Find the NPV of each of the three projects. Which project should the company undertake and why?Explanation / Answer
1. required rate of return = risk free + beta ( market return - risk free)
adscams =4.25 +1.2(10.5 - 4.25)
=11.75 %
Boondoggles = 4.25 + 0.9(10.5 - 4.25)
=9.875%
Closures= 4.25 +1.5(10.5 - 4.25)
=13.625%
2.NPV = present value of cash inflow - present value of cash outflow
Adscams = 6000* PVAF(11.75, 5years) - 12000
= 21763 - 12000
=$ 9763
Boondoggles = 10000 * PVAF (9.875 , 3years) - 18000
=24923 - 18000
=$6923
Closures = 11000 * PVAF (13.625, 4 years ) - 25000
=32299 - 25000
=$ 7299
3. Company should undertake project with highest npv but given projects have different life , therefore project should be selected in following manner
adscams = NPV / PVAF
=9763 / 3.6272
=$2692
Boondoggles = 6923 / 2.4923
=$2778
Closures = 7299 / 2.93625
=$2486
Boondoggles has highest npv , so this project should be undertaken..
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.