P12-20 Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in one of three mutually exclusive...
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P12-20 Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firm's cost of capital, r, is 10%, and the risk- free rate, R., is 2%. The firm has estimated each project's cash flow and each project's beta, as shown in the following table. Excel Where Project () E G Initial investment (CF.) Year (t) 2 3 4 Beta $15,000 -$11,000 -$19,000 Cash inflows (CF.) $6,000 $6,000 $4,000 6,000 4,000 6,000 6,000 5,000 8,000 0.000 2,000 12,000 1.80 1.00 0.60 a. Find the NPV of each project, using the firm's cost of capital. Which project is preferred in this situation? b. The firm uses the following equation to determine the risk-adjusted discount rate, RADR, for each project j: RADR;= Rp+B; x (m - Rp) Rp B RADR risk-free rate = 2% beta of project j risk-adjusted discount rate for project j expected return on market portfolio = 10% Substitute each project's beta into this equation to determine its RADR. c. Use the RADR for each project to determine its risk-adjusted NPV. Which project is preferable in this situation? d. Compare and discuss your findings in parts a and c. Which project do you recommend that the firm accept? P12-20 Risk-adjusted discount rates: Basic Country Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firm's cost of capital, r, is 10%, and the risk- free rate, R., is 2%. The firm has estimated each project's cash flow and each project's beta, as shown in the following table. Excel Where Project () E G Initial investment (CF.) Year (t) 2 3 4 Beta $15,000 -$11,000 -$19,000 Cash inflows (CF.) $6,000 $6,000 $4,000 6,000 4,000 6,000 6,000 5,000 8,000 0.000 2,000 12,000 1.80 1.00 0.60 a. Find the NPV of each project, using the firm's cost of capital. Which project is preferred in this situation? b. The firm uses the following equation to determine the risk-adjusted discount rate, RADR, for each project j: RADR;= Rp+B; x (m - Rp) Rp B RADR risk-free rate = 2% beta of project j risk-adjusted discount rate for project j expected return on market portfolio = 10% Substitute each project's beta into this equation to determine its RADR. c. Use the RADR for each project to determine its risk-adjusted NPV. Which project is preferable in this situation? d. Compare and discuss your findings in parts a and c. Which project do you recommend that the firm accept?
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