Risk-adjusted discount rates and risk classes) The G. Wolfe Corporation is exami

Question

Risk-adjusted discount rates and risk classes) The G. Wolfe Corporation is examining two capital-
budgeting projects with 5-year lives. The first, project A, is a replacement project; the second, project
B, is a project unrelated to current operations. The G. Wolfe Corporation uses the risk-adjusted discount rate method and groups projects according to purpose, and then it uses a required rate of return or discount rate that has been preassigned to that purpose or risk class. The expected cash flows
for these projects are given here:
PROJECT A PROJECT B
Initial investment _ $250,000 _$400,000
Cash inflows:
Year 1 $130,000 $135,000
Year 2 40,000 135,000
Year 3 50,000 135,000
Year 4 90,000 135,000
Year 5 130,000 135,000
The purpose/risk classes and preassigned required rates of return are as follows:
PURPOSE REQUIRED RATE OF RETURN
Replacement decision 12%
Modification or expansion of existing product line 15
Project unrelated to current operations 18
Research and development operations 20
Determine each project’s risk-adjusted net present value.

Explanation / Answer

Proj A id for replacemnt decision. So cost of capital is 12% NPV = NPV(rate, CFs) +CF0 = NPV(12%,130000,40000,50000,90000,130000)-250000 ie NPV of Proj A = $64,510 Proj B is unrelated to current operations. Its cost of cpaital is 18% NPVB= NPV(rate, CFs) +CF0 = NPV(18%,135000,135000,135000,135000,135000)-400000 ie NPV b= $22,168

Related Questions

Navigate

• Browse (All)
• Browse R
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.