Problem 10-9 Biased forecasts Cash flows for projects F and G are given below. C

Question

Problem 10-9 Biased forecasts

Cash flows for projects F and G are given below.

  

Cash Flows, ($)
Project C0 C1 C2 C3 C4 C5
F – 9,700 + 6,700 + 5,700 + 4,700 0 0
G – 9,700 + 1,940 + 1,940 + 1,940 + 1,940 + 1,940

  

The cost of capital for projects of this type is 12%. Assume that the forecasted cash flows are overstated and should be 6% lower than those provided by the project analyst. But a lazy financial manager, unwilling to take the time to argue with the projects’ sponsors, instructs them to use a discount rate of 18%. Assume the year 5 cash flow is a perpetuity.

  

a.

What are the projects’ true NPVs? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

  

NPV
  Project F $      
  Project G $      

  

b.

What are the NPVs at the 18% discount rate? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

  

NPV
  Project F $      
  Project G $      

Explanation / Answer

a.What are the projects’ true NPVs? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Project F

True NPVs = -9700 + 6298/1.12 + 5358/1.12^2 + 4418/1.12^3

True NPVs = $ 3,339.22

Project G

True NPVs = -9700 + 1823.6/1.12 + 1823.6/1.12^2 +1823.6/1.12^3 + 1823.6/1.12^ 4 + 1823.6/1.12^5

True NPVs = - $ 3,126.33

Working

What are the NPVs at the 18% discount rate? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Project F

NPVs = -9700 + 6700/1.18 + 5700/1.18^2 + 4700/1.18^3

NPVs = $ 2,932.18

Project G

NPVs = -9700 + 1940/1.18 +   1940/1.18^2 +  1940/1.18^3 +  1940/1.18^ 4 +  1940/1.18^5

NPVs = - $ 3,633.29

Project F Project G Year Cash Flow Correct Cash Flow Cash Flow Correct Cash Flow C0 -9700 -9700 -9700 -9700 C1 6700 6298.00 1940 1823.60 C2 5700 5358.00 1940 1823.60 C3 4700 4418.00 1940 1823.60 C4 0 0 1940 1823.60 C5 0 0 1940 1823.60

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