P12-12-Risk classes and RADR - Moses Manufacturing is attempting to select the b
ID: 2766612 • Letter: P
Question
P12-12-Risk classes and RADR - Moses Manufacturing is attempting to select the best of three mutually exclusive projects, X, Y, and Z. Although all the projects have 5-year lives, they possess different degrees of risk. Project X is class V, the highest risk class; project Y is II, the below average risk class; and project Z is class III, the average risk class. The basic cash flow data for each project and risk class and risk adjustment discount rates (RADRs) used by the firm are shown in the following tables.
a. Find the Risk-adjusted NPV for each project.
b. Which project, if any, would you recommend that the firm undertake?
Explanation / Answer
Project X should be selected since risk adjusted NPV is highest.
Project X
Project Y
Project Z
Intial investment
-177000
-2,39,000.000
-3,08,000.00
1
80000
51,000.000
95,000.00
2
70000
61,000.000
95,000.00
3
56000
79,000.000
95,000.00
4
61000
86,000.000
95,000.00
5
55000
90,000.000
95,000.00
Risk class
V
II
III
RADR
22.30%
0.136
0.16
Project X
dis factor @22.30%
Discounted cash flow
Intial investment
-177000
1.000
-1,77,000.00
1
80000
0.818
65,412.92
2
70000
0.669
46,799.92
3
56000
0.547
30,613.19
4
61000
0.447
27,266.16
5
55000
0.365
20,101.59
Risk adjusted NPV
13,193.79
Project Y
dis factor @13.60%
Discounted cash flow
Intial investment
-239000
1.000
-2,39,000.00
1
51000
0.880
44,894.37
2
61000
0.775
47,268.65
3
79000
0.682
53,888.00
4
86000
0.600
51,639.87
5
90000
0.529
47,571.94
Risk adjusted NPV
6,262.82
Project Z
dis factor @15.70%
Discounted cash flow
Intial investment
-308000
1.000
-3,08,000.00
1
95000
0.864
82,108.90
2
95000
0.747
70,967.07
3
95000
0.646
61,337.14
4
95000
0.558
53,013.95
5
95000
0.482
45,820.18
Risk adjusted NPV
5,247.25
Project X
Project Y
Project Z
Intial investment
-177000
-2,39,000.000
-3,08,000.00
1
80000
51,000.000
95,000.00
2
70000
61,000.000
95,000.00
3
56000
79,000.000
95,000.00
4
61000
86,000.000
95,000.00
5
55000
90,000.000
95,000.00
Risk class
V
II
III
RADR
22.30%
0.136
0.16
Project X
dis factor @22.30%
Discounted cash flow
Intial investment
-177000
1.000
-1,77,000.00
1
80000
0.818
65,412.92
2
70000
0.669
46,799.92
3
56000
0.547
30,613.19
4
61000
0.447
27,266.16
5
55000
0.365
20,101.59
Risk adjusted NPV
13,193.79
Project Y
dis factor @13.60%
Discounted cash flow
Intial investment
-239000
1.000
-2,39,000.00
1
51000
0.880
44,894.37
2
61000
0.775
47,268.65
3
79000
0.682
53,888.00
4
86000
0.600
51,639.87
5
90000
0.529
47,571.94
Risk adjusted NPV
6,262.82
Project Z
dis factor @15.70%
Discounted cash flow
Intial investment
-308000
1.000
-3,08,000.00
1
95000
0.864
82,108.90
2
95000
0.747
70,967.07
3
95000
0.646
61,337.14
4
95000
0.558
53,013.95
5
95000
0.482
45,820.18
Risk adjusted NPV
5,247.25
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