Chapter 12 -- Project Risk Analysis

PROBLEM 7

Virus Stopper Inc., a supplier of computer safeguard systems, uses a cost of capital of 12 percent

to evaluate average-risk projects, and it adds or subtracts 2 percentage points to evaluate projects

of more or less risk. Currently, two mutually exclusive projects are under consideration. Both

have a cost of $200,000 and will last four years. Project A, a riskier-than-average project, will

produce annual end-of-year cash flows of $71,104. Project B, of less than average risk, will

produce cash flows of $146,411 at the end of Years 3 and 4 only. Which project should Virus

Stopper accept?

ANSWER

Here are the cash flows of both projects: