g P12-8-Risk adjustment discount rates; Basic Country Wallpaper is considering i
ID: 2634839 • Letter: G
Question
g
P12-8-Risk adjustment discount rates; Basic Country Wallpaper is considering investing in one of three mutually exclusive projects, E, F, and G. The firms cost of capital, r is 15%, and the risk free rate is R, is10%. The firm has gathered the basic cash flow and risk index data for each project as shown in the following table.
Projects r
E F G
Initial investment (CFo) -$15,000 -$11,000 -$19,000
Cash inflows (CFt)
Years (t)
1 $6,000 $6,000 $4,000
2 6,000 4,000 6,000
3 6,000 5,000 8,000
4 6,000 2,000 12,000
Risk index (R1t) 1.8 1.00 0.60
a). Find the net present value (NPV) of each project using the firms cost of capital.
Which project is preferred in this situation?
b). The used the following equation ton determine the risk-adjusted discount rate RADR, for each project j:
RADR j= Rf + [ RIj x (r
Explanation / Answer
Particular/Year E F G 0 15000 11000 19000 1 6000 6000 4000 2 6000 4000 6000 3 6000 5000 8000 4 6000 2000 12000 RI 1.8 1 0.6 RADR=RF+RI*(r-Rf) 19 15 13 NPV E=6000/(1.19^1)+6000/(1.19^2)+6000/(1.19^3)+6000/(1.19^4)-15000 831.51 NPV F=6000/(1.15^1)+4000/(1.15^2)+5000/(1.15^3)+2000/(1.15^4)-11000 1673.05 NPV E=4000/(1.13^1)+6000/(1.13^2)+8000/(1.13^3)+12000/(1.13^4)-19000 2142.93
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