Harmony Industries uses the following table of risk-adjusted discount rates to a

Question

Harmony Industries uses the following table of risk-adjusted discount rates to analyze projects.

coefficient of variation . Discount rate

0-25......................................6%

.26-.50..................................8

.51-.75.................................10

.76-1.00...............................14

1.01-1.25............................20

The company is considering a $70,000 project. The coefficient of variation for the project is 0.847. Assume that the project generates the following cash flows:

Year cash flows

1...............$11,000

2.................16,000

3................21,000

4..................24,000

5..................30,000

Select the appropriate discount rate and compute the net present value. Should the project be undertaken?

Select one:

a. The project should not be undertaken because the NPV is -$2,987.

b. The project should be undertaken because the NPV is $1,870.

c. The project should be undertaken because the NPV is $3,457.

d. The project should not be undertaken because the NPV is -$4,096.

Explanation / Answer

The appropriate discount rate is% as the Cofficient of Variation is 0.847 which lies in 0.76 - 1 bracket.

Now NPV ={(11000/ 1.14) + (16000/1.142 ) + (21000/1.143) + (24000/1.144) + ( 30000/1.145) - 70000

NPV = 65904 -70000 = -4096 which is option C

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