The Biotek Corporation Has A Basic Cost Of Capital Of 15 Per

The Biotek Corporation Has A Basic Cost Of Capital Of 15 Percent And I

The Biotek Corporation is evaluating two potential investment projects, HiTek and LoTek, considering their respective cash flows, investment costs, and risk profiles. The primary decision-making framework involves calculating the projects' net present values (NPV), internal rates of return (IRR), and risk-adjusted NPVs to determine their viability and suitability for investment based on the company's cost of capital and risk management strategies.

Initially, the focus lies on evaluating the projects using traditional NPV calculations, where the value of future cash inflows is discounted at the company's baseline cost of capital of 15%. Subsequently, the IRR for each project is computed to identify the rate of return each project generates relative to its initial investment. Finally, adjustments are made for risk via risk-adjusted discount rates, incorporating risk premiums appropriate to each project's nature, thereby refining the valuation process in the context of the company's risk appetite.

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Investment decision-making within corporate finance hinges critically on accurately assessing the value added by potential projects. Key tools in this process include Net Present Value (NPV), Internal Rate of Return (IRR), and risk-adjusted valuation methods. For Biotek Corporation, with a stipulated cost of capital at 15%, these financial metrics serve as the basis for evaluating the profitability and acceptability of the proposed projects—HiTek and LoTek.

The initial step involves calculating the present value of each project’s expected cash inflows. For HiTek, with an initial outlay of $453,000, and cash inflows of $74,500 in Year 1, $83,700 in Year 2, and $54,000 in Year 3, the present value (PV) of inflows is computed by discounting each cash flow at 15%. Similarly, the calculations for LoTek, with an initial outlay of $276,000, involve discounting its cash inflows of $54,000, $83,700, and an unspecified third year's cash flow, to determine its PV.

Mathematically, the present value of each project’s inflows (PV_inflows) is calculated as:

Summing these, the total PV of inflows for HiTek is approximately $163,670. The NPV is then computed by subtracting the initial investment: NPV_HiTek = PV_inflows - $453,000 ≈ -$289,330. Because this is negative, the project based solely on unadjusted NPV would be rejected.

Applying a similar process to LoTek, with its cash inflows and initial investment, yields comparable PV calculations. Assuming the third-year inflow of LoTek is consistent with the second year's cash flow (or as given in the detailed data), the PV for LoTek can be computed, leading to its NPV calculation. If, for instance, cash flows are $54,000 in Year 1, $83,700 in Year 2, and Year 3, a similar discounted cash flow analysis enables evaluation of project viability.

Next, the IRRs for the projects are calculated by solving for the discount rate (r) where the NPV equals zero. For HiTek, the IRR can be determined by iterative methods or financial calculator functions, often resulting in an IRR below the company’s cost of capital, indicating lower profitability. If the IRR exceeds 15%, the project may be acceptable; otherwise, rejection is warranted.

Furthermore, risk-adjusted present values are considered to account for project-specific risk premiums. The company adds a risk premium of 3 percentage points for LoTek and 6 percentage points for HiTek, leading to adjusted discount rates of 18% and 21%, respectively. Discounting expected cash flows at these elevated rates provides a more conservative and risk-sensitive valuation.

The risk-adjusted NPV calculations involve discounting future cash flows at these adjusted rates, then subtracting the initial investments. If the risk-adjusted NPV for LoTek turns positive, it indicates that despite higher cost of capital, the project provides a value exceeding the adjusted expectations considering its risk profile. Conversely, if HiTek’s risk-adjusted NPV remains negative, it would suggest that the project is not worth pursuing given the increased risk premiums.

In conclusion, based on the thorough analysis, if HiTek’s NPV and risk-adjusted NPV are negative and its IRR is below the required rate, the company should reject it. Conversely, if LoTek’s NPVs are positive after risk adjustments and its IRR exceeds the risk-adjusted rate, then the project becomes an attractive investment. The decision to accept, reject, or pursue both projects depends on these financial metrics, aligning with the company's strategic risk tolerance and capital allocation policies.

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