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 risk-less 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:


Assume a $184,000 project provides the following inflows with the associated coefficients of variation for each year.


a. Fill in the following table:


b. If the risk-free rate is 5 percent, should this $184,000 project be accepted? Compute the net present value of the adjustedinflows.


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  • CreatedOctober 14, 2014
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