Question

11

Risk adjusted discount rates-8asic Country Wallpapers is considering nvesting in one of three mutually exclusive pro ect following basic cash flow and risk index data for each project a. Find the net present value (NPV) of each project using the firm's cost of capital. Which project is preferred in this situation? b. The firm uses the following equation to detemine the risk-adjusted discount rate, RADR, for each project j E, F and G. The firm's cost o capital r s 14.7% and the risk-free rate RF is 10.4%. The firm has gathered the DRR( -RF) where RF risk-free rate of return, RI, risk index for project J, andr -cost of capital. Substitute each projects risk index into this equation to determine its RADR c. Use the RADR for each project to determine its risk-adjusted NPV. Which project is preferable in this situation? d. Compare and discuss your findings in parts (a) and (c). Which project do you recommend that the firm accept? Project (j) Initial investment (CFo) $15,100 $11,000 $18,100 Year (t) Cash inflows (CFt) $3,900 6,300 8,100 12,000 0.62 $5,500 3,800 4,700 1,800 1.02 $6,200 6,200 6,200 6,200 1.77 4 Risk index (RI)

Answer 1

1 Cost of capital 2 riskfree rate 0.147 0.104 PROJECTS 5 initial investme 15100 -11000 18100 year 5500 3800 4700 180012000 1.02 1 6200 6200 6200 6200 1.77 3900 6300 8100 10 11 risk index 12 13 a) 14 NPV 15 project E is preferred since it has a higher NPV 16 b) 17 RADR 18 C) 19 NPV 20 d) 21 based on part c, project G is preferred since it has a higher NPV in this case 22 project G should be preferred since when adjusted for risk the cost of capital for project G is lower than that for project E 4 0.62 2,708.83 838.122,389.71 0.18011 0.14786 0.13066 1,574.82820.093,223.92

1 Cost of capital 2 riskfree rate 0.147 0.104 PROJECTS 4 5 initial investment 15100 11000 18100 year 6200 6200 6200 6200 1.77 5500 3800 4700 1800 1.02 3900 6300 8100 8 2 10 4 11 risk index 12 13 a) 14 NPV 15 project E is preferred since it 16 b) 17 RADR 18 C) 19 NPV 20 d) 21 based on part c, project G is pr 22 lproject G should be preferred 0.62 =NPV(B17,B7B10)+85 N PV(C17,C7:C10)+C5 ·-N PV(D17,D7:D10)+D5