Question: Risk adjusted rates of return using CAPM - Centennial Catering, Inc. is considering two mutually exclusive investments. The company wishes to use a CAPM type
Risk adjusted rates of return using CAPM - Centennial Catering, Inc. is considering two mutually exclusive investments. The company wishes to use a CAPM type risk-adjusted discount rate (RADR) in its analysis. Centennial's managers believe that the appropriate market rate of return is 121% and they observe that the current risk free rate of return is 7.4%. Cash flows associated with the two projects are shown in the following table:
| Project X | Project Y | |
| Initial investment (CF0) | $66,000 | $80,000 |
| Year (t) | Cash Inflows (CFt) | |
| 1 | $32,000 | $20,000 |
| 2 | $32,000 | $28,000 |
| 3 | $32,000 | $37,000 |
| 4 | $32,000 | $45,000 |
a. use a risk-adjusted discount rate approach to calculate the net present value of each project, given that project X has an RADR factor of 1.18 and project Y has an RADR factor of 1.38. The RADR factors are similar to project betas (Hint: Use the following equation to calculate the required project return for each: r = RF + b x (rm -Rf)).
b. discuss your findings in part (a) and recommend the preferred project.
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