Question: (EXCEL) P11-24 Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firms cost
(EXCEL)
P11-24 Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firms cost of capital, r, is 15%, and the risk-free rate, RF, is 10%. The firm has gathered the basic cash flow and risk index data for each project as shown in the following table.
| Project (j) | |||
|---|---|---|---|
| E | F | G | |
| Initial investment (CF0) | $15,000 | $11,000 | $19,000 |
| Year (t) | Cash inflows (CFt) | ||
| 1 | $6,000 | $6,000 | $ 4,000 |
| 2 | 6,000 | 4,000 | 6,000 |
| 3 | 6,000 | 5,000 | 8,000 |
| 4 | 6,000 | 2,000 | 12,000 |
| Risk index (RIj) | 1.80 | 1.00 | 0.60 |
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Find the net present value (NPV) of each project, using the firms cost of capital. Which project is preferred in this situation?
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The firm uses the following equation to determine the risk-adjusted discount rate, RADRj, for each project j:
RADRj=RF+[RIj(rRF)]RADRj=RF+[RIj(rRF)]
where
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RF = risk-free rate of return
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RIj = risk index for project j
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r = cost of capital
Substitute each projects risk index into this equation to determine its RADR.
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Use the RADR for each project to determine its risk-adjusted NPV. Which project is preferable in this situation?
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Compare and discuss your findings in parts a and c. Which project do you recommend that the firm accept?
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