P12-12 Risk classes and RADR Moses Manufacturing is attempting to select the bes

Question

P12-12 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 $180,000 $235,000 Initial investment (CFo) S310,000 Cash inflows (CF) Year $80,000 $50,000 $90,000 70,000 60,000 90,000 60,000 70,000 90,000 60,000 90,000 80,000 60,000 90,000 90,000 Risk Classes and RADRs Risk-adjusted Risk class Description discount rate (RADR Lowest risk 10% Below-average risk 13 Average risk 15 Above-average risk 19 Highest risk a. Find the risk-adjusted NPV for each project b. Which project, if any, would you recommend that the firm undertake?

Explanation / Answer

Firm should undertake project A because the return is higher

Particulars Year Cash Flow Project A Cash Flow Project B Cash Flow Project C PVF @ 22% PVF @ 13% PVF @ 15% PV project A PV project B PV project C Cash outflow 0 -180000 -235000 -310000 1 1 1 -180000 -235000 -310000 Present value of cash outflows -180000 -235000 -310000 1 80000 50000 90000 0.8197 0.885 0.8696 65576 44250 78264 2 70000 60000 90000 0.6719 0.7831 0.7561 47033 46986 68049 3 60000 70000 90000 0.5507 0.693 0.6575 33042 48510 59175 4 60000 80000 90000 0.4514 0.6133 0.5717 27084 49064 51453 5 60000 90000 90000 0.3699 0.5428 0.4972 22194 48852 44748 Present value of cash inflows 194929 237662 301689 Net Present value 14929 2662 -8311

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