Question1. The Seminole Production company is analyzing the investment in a new line os business machines. The initial outlay required is $35 million. The net cash flows anticipated from the investment are given below:
Year Net cash flow (Million)
1. $5
2. 8
3. 15
4. 20
5. 15
6. 10
7. 4
The firm's cost of capital (used for projects average of risk) is 15%.
a. Compute the net present value of this project assuming it possess average risk.
b. Due to the risk inherent in this type of investment, Seminole has decided to utilize the certainty equivalent approach. After considerable discussion, management had agreed to apply the following certainty equivalents to the project's cash flows are as follows:
Year ce
0. 1.00
1. 0.95
2. 0.90
3. 0.80
4. 0.60
5. 0.40
6. 0.35
7. 0.30
If the risk-free rate is 9%, compute the projects certainty equivalent net present value.
c. On the basis of the certainty equivalent analysis, should the project be accepted?