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(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 | 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 |
-
Find the net present value (NPV) of each project, using the firm’s cost of capital. Which project is preferred in this situation?
-
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
-
RF = risk-free rate of return
-
RIj = risk index for project j
-
r = cost of capital
Substitute each project’s risk index into this equation to determine its RADR.
-
-
Use the RADR for each project to determine its risk-adjusted NPV. Which project is preferable in this situation?
-
Compare and discuss your findings in parts a and c. Which project do you recommend that the firm accept?
Solutions
jeff jeffy answered 1 year agoRelated Solutions
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...
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