30. The Bull Company, a lawn mower manufacturer, is considering the introduction

Question

30. The Bull Company, a lawn mower manufacturer, is considering the introduction of a new model. The initial outlay required is $22 million. Net cash flows over the 4-year life cycle and the corresponding certainty-equivalents of the new model are as follows:

Year            Net Cash Flow            Certainty-equivalent Factor
1            $15 million            0.90
2            $13 million            0.75
3            $11 million            0.55
4            $ 9 million            0.30

The firm's cost of capital is 14% and the risk-free rate is 6%. Bull uses the certainty-equivalent approach in evaluating above-average risk investments such as this one. What is the project's certainty-equivalent NPV?       

A.       $20,083,000.28
B.       $6,631,663.90
C.       $13,905,000.72
D.       $3,019,400.20

Explanation / Answer

15000000 0.9 13500000 0.877 11842105 13000000 0.75 9750000 0.769 7502308 11000000 0.55 6050000 0.675 4083578 9000000 0.3 2700000 0.592 1598616 25019400.2 NPV = Cash Inflows- Cash Outflows NPV = 25019400.2-22000000 NPV = 3019400.2 The correct answer is D. $ 3019400.2

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