Risk-adjusted discount rates — Basic Country Wallpapers is considering investing

Question

Risk-adjusted discount rates—BasicCountry Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firm's cost of capital, r ,is 15.2%, and the risk-free rate, RF, is 9.6%.

The firm has gathered the 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 determine the risk-adjusted discount rate, RADRj for each project j:

RADRj=RF+RIj× (r- RF)

RF = risk-free rate of return, RIj= risk index for project j , and r = cost of capital.

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?

a. Find the net present value (NPV) of each project using the firm's cost of capital. The net present value for project E is $_______ (Round all answers to the nearest cent)

Project (j)

E F G

Initial investment (CFo) $14,900 $11,000 $18,200

Year (t)

1 $5,600 $6,000 $4,400

2 5,600 4,400 5,600

3 5,600 5,100 8,100

4 5,600 2,400 12,100

Risk Index (RIj) 1.83 0.95 0.59

Explanation / Answer

NPV can be calculated using NPV function in excel or calculator

With cost of capital = 15.2%, NPV for E = 1,023.41, for F = 2,222.42, G = 2,007.65

For E, RADRj can be calculated as 9.6% + 1.83 x (15.2% - 9.6%) = 19.85% and so on for other

With RADRj, NPV for E = -361.22, for F = 2,289.06, and for G = 3,164.67

E F G 0 -14900 -11000 -18200 1 5600 6000 4400 2 5600 4400 5600 3 5600 5100 8100 4 5600 2400 12100 NPV $1,023.41 $2,222.42 $2,007.65 Rij 1.83 0.95 0.59 RADRj 19.85% 14.92% 12.90% NPV -$ 361.22 $ 2,289.06 $ 3,164.67

Related Questions

Navigate

• Browse (All)
• Browse R
• Subjects

---

---

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