Mr. John Backster, a retired executive, desires to invest a portion of his assets in rental property. He has narrowed his choices to two apartment complexes, Windy Acres and Hillcrest Apartments. The anticipated annual cash inflows from each are as follows:

Windy Acres Hillcrest Apartments    Hillcrest Apartment

Yearly Aftertax Cash Inflow    Probability        Yearly Aftertax Cash Inflow    Probability

120,000                                .2                                  125,000                      .2

125,000                            .2                                  130,000                   .3

140,000                                .2                                  140,000                   .4

155,000                                .2                                  150,000                       .1

160,000                              .2   

Mr. Backster is likely to hold the apartment complex of his choice for about 25 years and will use this period for decision-making purposes. Either apartment can be purchased for $160,000. Mr. Backster uses a risk-adjusted discount rate approach when evaluating investments. His scale is related to the coefficient of variation (for other types of investments, he also considers other measures).

Coefficient of Variation                 Discount rate

0-0.35                                              8%

0.35-0.40                                       12 (cost of capital)

0.40-0.50                                       15

Over 0.50                                     Not considered

a. Compute the risk-adjusted net present value for Windy Acres and Hillcrest.

b.1. Which investment should Mr Backster accept if the two investment is mutually exclusive?

b.2. Which investment should Mr. Backster accept if the two investment is mutually exclusive and no capital rationing is involved?