ABC owns and operates a regional chain of motels in the Niagara Falls area and is looking
Question:
ABC owns and operates a regional chain of motels in the Niagara Falls area and is looking to expand into
Brampton. He is currently in discussion with two people about buying each of their motels. After reviewing
historical financial records, ABC has come up with the following estimates of cash flows for each of these
operations:
Tee Pee Motel Dodo Motel
After tax cashflow Probability Aftertax cashflow probability
70000 0.2 75000 0.2
75000 0.2 80000 0.3
90000 0.2 90000 0.4
105000 0.2 100000 0.1
110000 0.2
ABC is looking at a 25-year time horizon and will use this time period for decision-making purposes. Either motel
can be acquired for $200,000. ABC uses a risk-adjusted discount rate when considering investments. The scale is
related to the coefficient of variation.
Coefficient of variation Discount rate
0-0.35 7%
0.35-0.40 10% (cost of capital)
0.40-0.50 14%
over 0.50 not considered
a. Compute the risk-adjusted net present value for Tee-P-Teep Motel and Dodo Motel. (Round "PV Factor" to 3
decimal places. Do not round intermediate calculations. Round the final answers to nearest whole dollar.)
b. Which investment should Mr. Johnson accept if the two investments are mutually exclusive?
c. Which investment should Mr. Johnson accept If the investments are not mutually exclusive and no capital
rationing is involved?