Question: This question has 4 parts please answer them step by step for a child to understand. Alberta Limited is considering two mutually exclusive projects. The
This question has 4 parts please answer them step by step for a child to understand.
- Alberta Limited is considering two mutually exclusive projects. The relevant cash flows for each project are shown in the table below.
|
| Project Ajax | Project Eden |
| Initial Investment |
$55,000 |
$60,000 |
|
|
|
|
| Year | Net Cash Inflows | |
| 1 | $22,000 | $35,000 |
| 2 | $22,000 | $25,000 |
| 3 | $22,000 | $20,000 |
| 4 | $22,000 | $15,000 |
- Define the terms mutually exclusive projects and independent projects.
- Determine the payback period of each project. If the company has the maximum acceptable payback period of three years, which project(s) should the company invest in? Explain why.
- Suppose the company has a cost of capital of 12%. Determine the Net Present Value (NPV) of each project. Which project is preferred in this situation and why?
- The finance manager at Alberta Limited is considering using the following equation to determine the risk-adjusted discount rate for each project.
(RADRj)
| (RADRj) | = | RF + [bj (km - RF )] |
Where:
| RF | = | Risk-free rate of return |
| bj | = | Beta for project j |
| km | = | Cost of capital. |
Suppose the risk-free rate (RF ) observed in the market is 8% and the market rate of return (k is 14%. The beta (b, which is a measure of risk, for project Ajax is 0.75 and the beta for project Eden is 2.0. Determine the risk-adjusted net present value for each project. Which project is preferred in this situation and why?
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