The Dental Clinic, Inc. is contemplating replacing an obsolete word processing system with one of two innovative
Question:
The Dental Clinic, Inc. is contemplating replacing an obsolete word processing system with one of two innovative lines of equipment. Alternative 1 requires a current investment layout of $26,022, whereas alternative 2 requires an outlay of $31,048. The following cash flows (cost savings) will be generated each year over the five-year useful lives of the new systems.
Probability | Cash Flow | |
Alternative 1 | 0.32 | $7,000 |
0.36 | 10,000 | |
0.32 | 13,000 | |
Alternative 2 | 0.18 | $7,500 |
0.64 | 10,000 | |
0.18 | 12,500 |
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 15% for the cash flow with a higher degree of dispersion and a 12% rate for the less risky cash flows, calculate the expected net present value for each investment. Which alternative should be chosen?