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Jonathan is the owner of a small construction company. He is thinking about purchasing some construction equipment; however, he knows that the economy will have

Jonathan is the owner of a small construction company. He is thinking about purchasing some construction equipment; however, he knows that the economy will have a major impact on his future cash flows. He is not quite sure what to do with the scenario data that his financial officer gave him, and he is looking for your advice.

Scenario Analysis

Worst Case

Most Likely

Best Case

30% Probability

50%

Probability

20%

Probability

Cost of Investment (Year 0)

308,000

308,000

308,000

Year 1 Net Cash Flow

62,500

84,500

92,500

Year 2 Net Cash Flow

70,800

95,020

100,450

Year 3 Net Cash Flow

84,600

102,500

114,800

Year 4 Net Cash Flow

68,000

94,800

102,500

Year 5 Net Cash Flow

54,500

76,000

86,400

Salvage value (end of year 5)

12,000

26,000

38,000

You explain to him that the expected return of the project is the sum of the weighted expected returns from each scenario. Question 3.1 Does the project make sense if the cost of capital is 12%? Explain. Question 3.2 Does the project make sense if Jonathan demands an internal rate of return of 15%? Explain.

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