Chapter 12

Question 2

Adjusting for Risk: Docs R Us has performed a risk assessment of independent projects. They adjust for project risk by raising the calculated IRR by 3% for low risk projects, leaving the IRR the same for moderate risk projects, and lowering the calculated IRR by 2% for high risk projects.

Project	Cost	NVP	Risk IRR	Risk Level	ADJ IRR
A	$21,000	-$2,000	10%	Low
B	$17,000	$4,000	14%	Low
C	$15,000	$2,000	12%	High
D	$14,000	$4,000	15%	Average
E	$4,000	$1,000	11%	High

1. Without capital rationing, and given their cost of capital of 12%, and ignoring risk, based on IRR which projects should Meds R Us accept? Why?
2. B. Without capital rationing, and given their cost of capital of 12%, and considering risk, which projects should Meds R Us accept? Why?

Note that you will add 3% to the Projects IRR if it is low risk (making it look more favorable since it is), leave average risk Projects IRRs the same, and subtract 2% from the IRR for high risk Projects (making them less favorable since they are due to the risk).