P15.7 Investment Project Choice. Monk’s Coffee Shop is considering investment in two alter-…
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P15.7 Investment Project Choice. Monk’s Coffee Shop is considering investment in two alter- native capital budgeting projects. Project A is an investment of $75,000 to replace working but obsolete refrigeration equipment. Project B is an investment of $150,000 to expand dining room facilities. Relevant cash flow data for the two projects over their expected 2-year lives are as follows:
Project A
Year 1 Year 2
Probability Cash Flow Probability Cash Flow
0.18 $ 0 0.08 $ 0
0.64 50,000 0.84 50,000
0.18 100,000 0.08 100,000
Project B
Year 1 Year 2
Probability Cash Flow Probability Cash Flow
0.50
$ 0
0.125
$ 0
0.50
200,000
0.75
100,000
0.125
200,000
A. Calculate the expected value, standard deviation, and coefficient of variation of cash flows for each project.
B. Calculate the risk-adjusted NPV for each project using a 15% cost of capital for the riskier project and a 12% cost of capital for the less risky one. Which project is preferred using the NPV criterion?
C. Calculate the PI for each project, and rank the projects according to the PI criterion.
D. Calculate the IRR for each project, and rank the projects according to the IRR criterion.
E. Compare your answers to parts B, C, and D, and discuss any differences.
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