Real Time Systems Inc.is considering the development of one of two mutually exclusive new computer models.Each will require a net investment of $5,000.The cash flow figures for each project are shown below: Model B,which will use a new type of laser disk drive,is considered a high-risk project,while Model A is of average risk.Real Time adds 2 percentage points to arrive at a risk-adjusted discount rate when evaluating a high-risk project.The rate used for average risk projects is 12 percent.Which of the following statements regarding the NPVs for Models A and B is most correct? A) NPV_A = $380; NPV_B = $1,815. B) NPV_A = $197; NPV_B = $1,590. C) NPV_A = $380; NPV_B = $1,590. D) NPV_A = $5,380; NPV_B = $6,590. E) None of the above statements is correct.

Question

Quizplus · Accepted Answer

To calculate the NPV for each project, we need to discount the cash flows using the appropriate risk-adjusted discount rate.
For Model A:
NPV = (-$5,000) + ($1,200 / 1.12) + ($2,000 / 1.12^2) + ($3,000 / 1.12^3) + ($2,500 / 1.12^4) = $380.27
For Model B, we first need to apply the risk adjustment and use a discount rate of 14%:
NPV = (-$5,000) + ($1,500 / 1.14) + ($2,000 / 1.14^2) + ($1,500 / 1.14^3) + ($3,000 / 1.14^4) + ($4,500 / 1.14^5) = $1,589.50
Therefore, the most correct statement is C, which correctly states the NPVs for Models A and B.