Question

# Risk classes and RADR   Moses Manufacturing is attempting to select the best of three mutually exclusive​...

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?

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