Question

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 15.4%, 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, RADR;, for each projectſ: RADR; = Rp+RI;*(r-RF) where Re = risk-free rate of return, RI; = risk index for project j, and r = cost of capital. Substitute each project's risk index into this equation to determine its RADR. 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?

Answer 1

1.
=-15500+5800/1.154+5800/1.154^2+5800/1.154^3+5800/1.154^4=925.784095125257

2.
=-11000+5600/1.154+4200/1.154^2+4800/1.154^3+2300/1.154^4=1426.77896298687

3.
=-18300+3600/1.154+6700/1.154^2+7300/1.154^3+12000/1.154^4=1367.22145110041

4.
Project F

5.
=9.6%+1.79*(15.4%-9.6%)
=19.9820%

6.
=9.6%+1.05*(15.4%-9.6%)
=15.6900%

7.
=9.6%+0.64*(15.4%-9.6%)
=13.3120%

8.
=-15500+5800/1.19982+5800/1.19982^2+5800/1.19982^3+5800/1.19982^4
=-480.2161

9.
=-11000+5600/1.1569+4200/1.1569^2+4800/1.1569^3+2300/1.1569^4=1362.4391

10.
=-18300+3600/1.13312+6700/1.13312^2+7300/1.13312^3+12000/1.13312^4=2391.9846

11.
Project G

12.
Project G as the discount rate should be based on risk