Question

In: Finance

Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in one of three mutually exclusive projects,...

Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firm’s cost of capital, r, is 15%, and the risk-free rate, RF, is 10%. The firm has gathered the basic cash flow and risk index data for each project as shown in the following table.

Project (j)
E F G
Initial investment (CF0) −$15,000−$15,000 −$11,000−$11,000 −$19,000−$19,000
Year (t) Cash inflows (CFt)
1       $6,000       $6,000     $  4,000
2         6,000         4,000         6,000
3         6,000         5,000         8,000
4         6,000         2,000       12,000
Risk index (RIj)           1.80           1.00           0.60
  1. Find the net present value (NPV) of each project, using the firm’s cost of capital. Which project is preferred in this situation?

  2. The firm uses the following equation to determine the risk-adjusted discount rate, RADRj, for each project j:

    RADRj=RF+[RIj×(r−RF)]RADRj=RF+[RIj×(r−RF)]

    where

    RFRIjr===risk-free rate of returnrisk index for project jcost of capitalRF=risk-free rate of returnRIj=risk index for project jr=cost of capital

    Substitute each project’s risk index into this equation to determine its RADR.

  3. Use the RADR for each project to determine its risk-adjusted NPV. Which project is preferable in this situation?

  4. Compare and discuss your findings in parts a and c. Which project do you recommend that the firm accept?

Solutions

Expert Solution

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE


Related Solutions

(EXCEL) P11-24 Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in one of three mutually...
(EXCEL) P11-24 Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firm’s cost of capital, r, is 15%, and the risk-free rate, RF, is 10%. The firm has gathered the basic cash flow and risk index data for each project as shown in the following table. Project (j) E F G Initial investment (CF0) −$15,000 −$11,000 −$19,000 Year (t) Cash inflows (CFt) 1 $6,000 $6,000 $ 4,000 2...
Your company is considering investing in one of two mutually exclusive projects. The cost of capital...
Your company is considering investing in one of two mutually exclusive projects. The cost of capital is 11%. The first project Has $25,000 annual cash inflows, a 10-year life, and will cost $120,000 at time zero. The second project has a 7-year life, Annual cash inflows of $20,000 per year, and a cost of $75,000 at time zero. Which project has the highest NPV. Assuming that these projects will most likely be repeated indefinitely into the future, which project would...
Your company is considering investing in one of two mutually exclusive projects. The cost of capital...
Your company is considering investing in one of two mutually exclusive projects. The cost of capital is 11%. The first project Has $25,000 annual cash inflows, a 10-year life, and will cost $120,000 at time zero. The second project has a 7-year life, Annual cash inflows of $20,000 per year, and a cost of $75,000 at time zero. Which project has the highest NPV. Assuming that these projects will most likely be repeated indefinitely into the future, which project would...
​(​Risk-adjusted NPV​) The Hokie Corporation is considering two mutually exclusive projects. Both require an initial outlay...
​(​Risk-adjusted NPV​) The Hokie Corporation is considering two mutually exclusive projects. Both require an initial outlay of ​$13, 000 and will operate for 7 years. Project A will produce expected cash flows of ​$4,000 per year for years 1 through 7​, whereas project B will produce expected cash flows of ​$5,000 per year for years 1 through 7. Because project B is the riskier of the two​ projects, the management of Hokie Corporation has decided to apply a required rate...
​(​Risk-adjusted NPV​)  The Hokie Corporation is considering two mutually exclusive projects. Both require an initial outlay...
​(​Risk-adjusted NPV​)  The Hokie Corporation is considering two mutually exclusive projects. Both require an initial outlay of ​$10 comma 000 and will operate for 5 years. Project A will produce expected cash flows of ​$5 comma 000 per year for years 1 through 5​, whereas project B will produce expected cash flows of ​$6 comma 000 per year for years 1 through 5. Because project B is the riskier of the two​ projects, the management of Hokie Corporation has decided...
(​Risk-adjusted NPV​) The Hokie Corporation is considering two mutually exclusive projects. Both require an initial outlay...
(​Risk-adjusted NPV​) The Hokie Corporation is considering two mutually exclusive projects. Both require an initial outlay of ​$13,000 and will operate for 9 years. Project A will produce expected cash flows of ​$5,000 per year for years 1 through 9​, whereas project B will produce expected cash flows of ​$6,000 per year for years 1 through 9. Because project B is the riskier of the two​ projects, the management of Hokie Corporation has decided to apply a required rate of...
Stephens, Inc. is considering investing in one of two mutually exclusive 4-year projects. Project A requires...
Stephens, Inc. is considering investing in one of two mutually exclusive 4-year projects. Project A requires equipment with a cost of $140,000 and increases net income by $5,000, $10,000, $20,000 and $30,000 in years 1-4, respectively. Project B requires equipment with a cost of $200,000 and increases cash flow by $70,000 per year in years 1-4. Both projects have a 4-year life and the equipment will be depreciated using straight-line depreciation. What is the NPV of project A at a...
KORONA Manufacturing is considering investing in either of two mutually exclusive projects, A and B. The...
KORONA Manufacturing is considering investing in either of two mutually exclusive projects, A and B. The firm has a 14 percent cost of capital, and the risk-free rate is currently 9 percent. The initial investment, expected cash inflows, and certainty equivalent factors associated with each of the projects are shown in the following table. Project A Project B Initial investment (II) $ 40,000 $ 56,000 Year (t) Cash inflows (CFt) Certainty equivalent factors (αt) Cash inflows (CFt) Certainty equivalent factors...
ABC Company is considering investing in two mutually exclusive projects, L and S. The two projects’...
ABC Company is considering investing in two mutually exclusive projects, L and S. The two projects’ forecasted cash flows are shown as below. WACC is 10%. Year 0 1 2 3 4 Project L CF ($) -1,000    700 500 200 0 Project S CF ($) -1,200 100 300 800 1,000 a. Calculate the NPVs for both projects. b. Calculate the IRRs for both projects. c. Calculate the Discounted Paybacks for both projects. [Draw a timeline] d. Based on your...
2.) Mutually exclusive projects may be ranked differently when higher or lower discount rates are used....
2.) Mutually exclusive projects may be ranked differently when higher or lower discount rates are used. a. True b. False 13.) The option to abandon a project before the end of its forecasted life may increase its NPV. a. True b. False 18.) Porter Climate Control is evaluating a proposal to move some manufacturing operations from an obsolescent plant in Illinois to a new facility in Mexico. The new facility will cost $58 million to open. and is expected to...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT