Montrose Manufacturing is considering two potential investments

| February 25, 2017

Question
Montrose Manufacturing is considering two potential investments. Each project will cost $70,000 and have an expected life of five years. The CFO has estimated the probability distributions for each project’s cash flows as shown in the following table:
Potential Cash Flows
Probability Project 1 Project 2
25% $12,000 $10,000
50% 27,000 30,000
25% 36,000 46,000

The company believes that the probability distributions apply to each year of the five years of the projects’ lives. Montrose Manufacturing uses the risk-adjusted discount rate technique to evaluate potential investments.

As a guide for assigning the risk premiums, the CFO has put together the following table based on the coefficient of variation:

Coefficient of Variation Risk Premium
0.00 -1.50%
0.20 0.00%
0.30 1.00%
0.40 1.50%
0.50 2.50%

a. Calculate the expected cash flows, standard deviation, and coefficient of variation for each project.

b. If the firm’s WACC for average risk projects is 10%, what is the appropriate risk-adjusted discount rate for each project? Use the VLookup function to calculate the project WACC.

c. Using the appropriate discount rates, calculate the payback period, discounted payback period, NPV, PI, IRR, and MIRR for each project.

d. If the projects are mutually exclusive, which should be accepted? What if they are independent?

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