Question

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Lab 7 (C11) FIN 203 - Exce Home Insert Draw Page Layout Formulas Data Review View Help Tell me what you want to do = Copy Format Painter Calibri BIU. -12 . A À . A 23 Wrap Text Merge & Center - Mignment Percentage $ -% Number - 53-43 S 162,021 Maya, the treasurer, believes the projects are not equally risky. She believes the firm should demand higher returns from riskier projects. She analyzes the variability of the estimated cash flows and concludes that The following discount rates would the most appropriate for each project: Project A: 12%. Project B:15%. Project 20% 65 21 6 Calculate the NPV of each project using its risk-adjusted discount rate: Which project has the most favorable risk adjusted NPV

Answer 1

The risk-adjusted discount rate is based on the risk-free rate and a risk premium. The risk premium is derived from the level of risk associated with a stream of CF for which the discount rate will be used to arrive at a NPV. The risk premium is adjusted upward if the level of investment risk is perceived to be high. When a high risk-adjusted discount rate is applied to a stream of cash flows, the net present value of those cash flows will be greatly reduced. A proposed investment with a higher net present value is more likely to be accepted. Thus, the discount rate is used to judge whether a proposed investment is acceptable.

So to calculate NPV do the following. Project A $162.02/1.12 Project B $16.8/1.15 So whichever has high NPV that project will be tenable.