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P14.6 Risk-Adjusted Discount Rates. One-Hour Dryclean, Inc., is contemplating replacing an obsolete dry-cleaning machine with one of two innovative pieces of equipment. Alternative 1 requires a current investment outlay of $25,373, whereas alternative 2 requires an outlay of
$24,199. The following cash flows (cost savings) will be generated each year over the new machines’ 4-year lives:
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|
 |
Probability |
Cash Flow |
|
Alternative 1 |
0.18 |
$ 5,000 |
|
 |
0.64 |
10,000 |
|
 |
0.18 |
15,000 |
|
Alternative 2 |
0.125 |
$ 8,000 |
|
 |
0.75 |
10,000 |
|
 |
0.125 |
12,000 |
A.   Calculate the expected cash flow for each investment alternative.
B.    Calculate the standard deviation of cash flows (risk) for each investment alternative.
C.    The firm will use a discount rate of 12% for the cash flows with a higher degree of disper- sion and a 10% rate for the less risky cash flows. Calculate the expected net present value for each investment. Which alternative should be chosen
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