Question

Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Inc., as Vice-President of Finance. She believes in adjusting projects for risk. Her father is somewhat skeptical but agrees to go along with her. Her approach is somewhat different than the risk-adjusted discount rate approach, but achieves the same objective. She suggests that the inflows for each year of a project be adjusted downward for lack of certainty and then be discounted back at a risk-free rate. The theory is that the adjustment penalty makes the inflows the equivalent of riskless inflows, and therefore a risk-free rate is justified.

A table showing the possible coefficient of variation for an inflow and the associated adjustment factor is shown next:
  

Coefficient of Variation			Adjustment Factor
0	−	0.25		0.90
0.26	−	0.50		0.80
0.51	−	0.75		0.70
0.76	−	1.00		0.60
1.01	−	1.25		0.50

Assume a $185,000 project provides the following inflows with the associated coefficients of variation for each year.
  

Year	Inflow		Coefficient of Variation
1	$	32,000			0.16
2		59,600			0.20
3		77,000			0.48
4		62,200			0.72
5		67,000			1.14

  
Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Fill in the table below: (Do not round intermediate calculations. Round "Adjustment Factor" answers to 2 decimal places and other answers to the nearest whole dollar.)
  

  
b-1. If the risk-free rate is 7 percent, compute the net present value of the adjusted inflows. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)
  

  
b-2. Should this project be accepted?
  

• Yes

• No

Answer 1

Part A - FIlling up the table

Risk adjuested factor taken from Table A. Multiply them with CI to get Adjusted CI. Now this adjusted cash flow should be used for calculating NPV. Table is produced below with formula

NPV calculation is shown below

SInce the NPV of the project is negative, it should not be accepted