Pueblo Enterprises is considering investing in either of two mutually exclusive

Question

Pueblo Enterprises is considering investing in either of two mutually exclusive projects X and Y. Project X requires an initial investment of $30,000; project Y requires $40,000. Each projects cash inflows are 5-year annuities. Project X inflows are $10,000 per year; project Y are $15,000. The firm has unlimited funds and in the absence of risk differences, accepts the project with the highest NPV. The cost of capital is 15%. A. Find the NPV for each project.Are the projects acceptable? B. Find the breakeven cash inflow for each project. C. The firm has estimated the probablities of achieving various ranges of cash inflows for the two projects, as shown in the following table. What is the probability that each project will achieve the breakeven cash inflow found in part B? D. Which project is more risky? Which project has the potentially higher NPV? Discuss the risk-return tradeoffs of the two projects. E. If the firm wished to minimize losses (that is, NPV<$0), which project would you recommend? Which would you recommend if the goal was acheiving a higher NPV? Range of cash inflow Project X Project Y $0-5,000 0% 5% 5,000 - 7,500 10 10 7,500 - 10,000 60 15 10,000 - 12,500 25 25 12,500 - 15,000 5 20 15,000 - 20,000 0 15 above 20,000 0 20

Explanation / Answer

PORJECT X

PORJECT Y

PV =PMT x (pvifa 15% years)

PV =PMT x (pvifa 15% years)

Pv =10 000 x 3.352

Pv =15 000 x 3.352

PVn=33520

PVn=50280

NPV= PVn-INITIAL IVESTSMNET

NPV= PVn-INITIAL IVESTSMNET

=33520-30000

=50280-40000

NPV= 3520

NPV= 10 280

PORJECT X

PORJECT Y

SCF x 3.352 =30000

SCF x 3.352 =40000

SCF =8949.88

SCF =11 933.17

PROJECT X –PROBABILITY =60%

PROJECT Y –PROBABILITY =25%

PROJECT Y IS MORE RISKY AND HAD HIGHER POTENTIAL NPV.PROJECT X HAS ;ESS RISK AND LESS RETUNE WHILE PROJECT Y HAS MORE RISK AND MORE RETURN THUS THE RISK RETUEN TRADE OFF.

CHOSOE PROEJCT X TO MINIMISE LOSSES ,

TO ACHIEVE HIGEHR NPV,CHOOSE PROJECT Y

PORJECT X

PORJECT Y

PV =PMT x (pvifa 15% years)

PV =PMT x (pvifa 15% years)

Pv =10 000 x 3.352

Pv =15 000 x 3.352

PVn=33520

PVn=50280

NPV= PVn-INITIAL IVESTSMNET

NPV= PVn-INITIAL IVESTSMNET

=33520-30000

=50280-40000

NPV= 3520

NPV= 10 280

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