Q1. Investment Project Choice.Toby Amberville's Manhattan Cafe, Inc., is considering investment in two alternative capital budgeting projects. Project A is an investment of $75000 to replace working but obsolete refrigeration equipment. Project B is an investment of $150000 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

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

1. Calculate the risk-adjusted NPV for each project using a 15 per cent cost of capital for the riskier project and a 12 per cent cost of capital for the less risky one. Which project is preferred using the NPV criterion?

1. Calculate the PI for each project, and rank the projects according to the PI criterion.

1. Calculate the IRR for each project, and rank the projects according to the IRR criterion.

1. Compare your answers to parts B, C, and D, and discuss any differences.

Q2. Cash Flow Estimation.Cunningham'sDrugStore,amedium-sizedrugstorelocatedinMilwaukee,Wisconsin,isownedandoperatedbyRichardCunningham.Cunningham'ssellspharmaceuticals,cosmetics,toiletries,magazines,andvariousnovelties.Cunningham'smostrecentannualnetincomestatementisasfollows:

Salesrevenue	$1,800,000
Totalcosts
Costofgoodssold	$1,260,000
Wagesandsalaries	200,000
Rent	120,000
Depreciation	60,000
Utilities	40,000
Miscellaneous	30,000
Total Costs	1,710,000
Netprofitbeforetax	$90,000

Cunningham'ssalesandexpenseshaveremainedrelativelyconstantoverthepastfewyearsandareexpectedtocontinueunchangedinthenearfuture.Toincreasesales,Cunninghamisconsideringusingsomefloorspaceforasmallsodafountain.Cunninghamwouldoperatethesodafountainforaninitialthree-yearperiodandthenwouldreevaluateitsprofitability.Thesodafountainwouldrequireanincrementalinvestmentof$20,000toleasefurniture,equipment,utensils,andsoon.Thisistheonlycapitalinvestmentrequiredduringthethree-yearperiod.Attheendofthattime,additionalcapital wouldberequiredto continueoperatingthe sodafountain, and nocapitalwouldberecoveredifitwereshutdown.Thesodafountainisexpectedtohaveannualsalesof$100,000andfoodandmaterialsexpensesof$20,000peryear.Thesodafountainisalsoexpectedtoincreasewageandsalaryexpensesby8%andutilityexpensesby5%.Becausethesodafountainwillreducethefloorspaceavailablefordisplayofothermerchandise,salesofotherfountainitemsareexpectedtodeclineby10%.

1. Calculatenetincrementalcashflowsforthesodafountain.

1. AssumethatCunninghamhasthecapitalnecessarytoinstallthesodafountainandthatheplacesa12%opportunitycostonthosefunds.Shouldthesodafountainbeinstalled?Whyorwhynot?

Q3. Cash Flow Analysis.Dunder-Mifflin,Inc.,isanalyzingthepotentialprofitabilityofthreeprintingjobsputupforbidbytheStateDepartmentofRevenue:

	JobA	JobB	Job C
Projectedwinningbid(perunit)	$5.00	$8.00	$7.50
Directcostperunit	$2.00	$4.30	$3.00
Annualunitsalesvolume	800,000	650,000	450,000
Annualdistributioncosts	$90,000	$75,000	$55,000
Investmentrequiredtoproduceannualvolume	$5,000,000	$5,200,000	$4,000,000

Assumethat:

(1)thecompany'smarginalcity-plus-state-plus-federaltaxrateis50%;

(2)eachjobisexpectedtohaveasix-yearlife;

(3)thefirmusesstraight-linedepreciation;

(4)theaveragecostofcapitalis14%;

(5)thejobshavethesameriskas thefirm'sotherbusiness;and

(6)thecompanyhasalreadyspent$60,000ondevelopingtheprecedingdata.This$60,000hasbeencapitalizedandwillbeamortizedoverthelifeoftheproject.

1. Whatistheexpectednetcashfloweachyear?(Hint:Cashflowequalsnetprofitaftertaxesplusdepreciationandamortizationcharges.)

1. Whatisthenetpresentvalueofeachproject?Onwhichproject,ifany,shouldthecompanybid?

1. SupposethatDunder-Mifflin'sprimarybusinessisquitecyclical,improvinganddecliningwiththeeconomy,butthatjobAisexpectedtobecountercyclical.Mightthishaveanybearingonyourdecision?

Q4. A manager must determine which of two products to market. From market studies, the manager constructed the following payoff matrix of the present value of all future net profits under all the different possible states of the economy:

Product 1
State of the economy	Probability	Profit ($)
Boom	0.2	50
Normal	0.5	20
Recession	0.3	0
Product 2
State of the economy	Probability	Profit ($)
Boom	0.2	30
Normal	0.4	20
Recession	0.4	10

The manager's utility function for money is

U = 100M - M²

where U is the total utility of money (in utils) and M refers to the dollars of profit.

1. Determine if this manager a risk seeker, risk neutral, or a risk averter.
2. If the manager's objective was profit maximization regardless of risk, which product should the manager introduces?
3. Evaluate the risk associated per dollar of profit with each product.
4. If the manager's objectives were utility maximization, which product should the manager introduce? (Hint: in this section, you can assume the same probability distribution indicated in the table above.)