Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Concept explainers
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Question
![Providence Health is evaluating two different linen supply vendors systems for handling facility linen replacement.
There are no incremental revenues attached to the projects, so the decision will be made on the basis of
the present value of costs. Providence's weighted average cost of capital is 6.25%. Here are the net cash flow
estimates in thousands of dollars:
Year
0
1
2
3
4
5
System X System Y
S (1,800) $ (3,850)
S (1,000) S (500)
(1,000) S
(500)
S
S (1,000) S
S (1,000) S
S (1,000) S
(500)
(500)
(500)
[a] Assume initially that the systems both have average risk. Which one should be chosen?
[b] Assume that System Y is judged to have high risk. The organization
accounts for differential risk by adjusting its corporate cost of capital](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F8c8f8f38-b957-43cd-be1d-7f3a0b16f059%2Fb62a5042-abad-4df1-b5fd-e26511151c76%2F0b7wyqo_processed.jpeg&w=3840&q=75)
Transcribed Image Text:Providence Health is evaluating two different linen supply vendors systems for handling facility linen replacement.
There are no incremental revenues attached to the projects, so the decision will be made on the basis of
the present value of costs. Providence's weighted average cost of capital is 6.25%. Here are the net cash flow
estimates in thousands of dollars:
Year
0
1
2
3
4
5
System X System Y
S (1,800) $ (3,850)
S (1,000) S (500)
(1,000) S
(500)
S
S (1,000) S
S (1,000) S
S (1,000) S
(500)
(500)
(500)
[a] Assume initially that the systems both have average risk. Which one should be chosen?
[b] Assume that System Y is judged to have high risk. The organization
accounts for differential risk by adjusting its corporate cost of capital
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