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 $150,000 project provides the following inflows with the associated coefficients of variation for each year. Year Inflow Coefficient of Variation 1 $ 36,400 0.14 2 53,000 0.29 3 73,500 0.54 4 61,000 0.81 5 64,900 1.11 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 6 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? No Yes

Answer 1

Year	Inflow	Co efficient of adjustment	Relating Adjustment factor	Inflow after Adjustment	PV @ 6% for $1	Discounted Inflow @ PV 6%
1	$ 36,400.00	0.14	0.9	$                            32,760.00	0.943396226	$             30,905.66
2	$ 53,000.00	0.29	0.8	$                            42,400.00	0.88999644	$             37,735.85
3	$ 73,500.00	0.54	0.7	$                            51,450.00	0.839619283	$             43,198.41
4	$ 61,000.00	0.81	0.6	$                            36,600.00	0.792093663	$             28,990.63
5	$ 64,900.00	1.11	0.5	$                            32,450.00	0.747258173	$             24,248.53
				Net Present Value		$         1,65,079.08
				Investment		$         1,50,000.00
				Net inflow from project		$             15,079.08

Inflow and Co efficient of adjustment was done as given the problem.

Adjustment factor for the Co efficient of adjustment is taken from the Table given.

Inflow after Adjustment = Inflow X Relating Adjustment factor

PV @ 6% for $1 is calculated as  

where

"r" is the discount rate, "n" equals the time period.

Discounted inflow is calculated as

Discounted inflow = inflow after adjustment X PV @ 6% for $1

NPV of adjusted inflow is $ 1,65,079.08

As Net inflow from the project is POSITIVE, the project can be ACCEPTED.