5. Risk Governors Ltd (RGL) is considering two mutually exclusive proposals both having an initial outlay...

 

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5. Risk Governors Ltd (RGL) is considering two mutually exclusive proposals both having an initial outlay of Tshs 900 million. The proposals denoted as A and B, have uncertain cash inflows depending upon the market conditions. There are four possible market scenarios having probabilities of 20%, 40%, 20% and 20%. The cash inflows of A and B under four possible market conditions are forecast as follows: Market Scenario Cash Flows in Tshs million B 220 240 265 280 Probability A I 0.20 200 II 0.40 250 III 0.20 280 IV 0.20 300 The firm recognizes the fact that project appraisal must consider the riskiness of the cash flows. To objectively decide upon the appropriate discount rate the management of RGL has devised a formula for arriving at the Risk Adjusted Discount Rate (RADR) based on the coefficient of variation (CV) as follows: RADR = 8% + CV x 25%. Required: Assuming that each proposal lasts for 5 years and RADR is used to evaluate the proposals which one would you prefer and why? 5. Risk Governors Ltd (RGL) is considering two mutually exclusive proposals both having an initial outlay of Tshs 900 million. The proposals denoted as A and B, have uncertain cash inflows depending upon the market conditions. There are four possible market scenarios having probabilities of 20%, 40%, 20% and 20%. The cash inflows of A and B under four possible market conditions are forecast as follows: Market Scenario Cash Flows in Tshs million B 220 240 265 280 Probability A I 0.20 200 II 0.40 250 III 0.20 280 IV 0.20 300 The firm recognizes the fact that project appraisal must consider the riskiness of the cash flows. To objectively decide upon the appropriate discount rate the management of RGL has devised a formula for arriving at the Risk Adjusted Discount Rate (RADR) based on the coefficient of variation (CV) as follows: RADR = 8% + CV x 25%. Required: Assuming that each proposal lasts for 5 years and RADR is used to evaluate the proposals which one would you prefer and why?

Answer rating: 100% (QA)

Solution To evaluate the proposals we need to calculate the Risk Adjusted Discount Rate RADR for eac... View the full answer