Question

Risk classes and RADR   Moses Manufacturing is attempting to select the best of three mutually exclusive​ projects, X,​ Y, and Z. Although all the projects have

5

​-year

​lives, they possess differing degrees of risk. Project X is in class​ V, the​ highest-risk class; project Y is in class​ II, the​ below-average-risk class; and project Z is in class​ III, the​ average-risk class. The basic cash flow data for each project and the risk classes and​ risk-adjusted discount rates​ (RADRs) used by the firm are shown in the following tables

	Project X	Project Y	Project Z
Initial Investment (CF0)	177000	237000	311000
Year (t)		Cash inflows
1	81000	59000	95000
2	70000	70000	95000
3	62000	78000	95000
4	63000	81000	95000
5	65000	99000	95000

Risk Classes and RADRs
Risk Class	Description	Risk adjusted discount rate​ (RADR)
I	Lowest risk	10.4 %

II	​Below-average risk	13.3
III	Average risk	15.1
IV	​Above-average risk	19.2
V	Highest risk	22.1

a. Find the ​risk-adjusted NPV for each project.

b. Which​ project, if​ any, would you recommend that the firm​ undertake?

Answer 1

For each project we will calculate the NPV using risk adjusted discout rate

Project X = 22.1%

Project Y = 13.3%

Project Z = 15.1%

Project X	Cash Flow	PV @ 22.1%
Initial Investment (CF0)	-177,000	-177,000
Year (t)
1	81,000	66,339
2	70,000	46,953
3	62,000	34,060
4	63,000	28,345
5	65,000	23,952
Risk Adjusted NPV		22,649

Project Y	Cash Flow	PV @ 13.3%
Initial Investment (CF0)	-237,000	-237,000
Year (t)
1	59,000	52,074
2	70,000	54,530
3	78,000	53,630
4	81,000	49,155
5	99,000	53,026
Risk Adjusted NPV		25,414

Project Z	Cash Flow	PV @ 15.1%
Initial Investment (CF0)	-311,000	-311,000
Year (t)
1	95,000	82,537
2	95,000	71,709
3	95,000	62,301
4	95,000	54,128
5	95,000	47,027
Risk Adjusted NPV		6,702

Since Projects are mutually exclusive firm should accept project with highest NPV ie Project Y