Other information: APR: 8.25% Equity:15% (regular Projects) Debt:48%: Equity:52%

Question

Other information: APR: 8.25% Equity:15% (regular Projects) Debt:48%: Equity:52%

Question

1.Using the risk adjusted discount rate, assess the attractiveness of the project.

2.Using the certainty equivalent cash flow approach, assess the attractiveness of the project.

3. Do either of the adjustments change the decision? What would you recommend to the company?

Project Cost: $19,000,000

Internal Rate of Return: $15.54424%

Use a 4.5% higher discount rate for the RADF method

CECF Approach:

Year 1:96%

Year 11:39%

Year 2:91%

Year 12:33%

Year 3:85%

Year 13:29%

Year 4:79%

Year 14:26%

Year 5:74%

Year 15:23%

Year 6:68%

Year 16:20%

Year 7:62%

Year 17:18%

Year 8:56%

Year 18:1     5%

Year 9:50%

Year 19:13%

Year 10:45%

Year 20:12%

Exhibit 1. Project Cash flow and Return

Year

Net Cash flow ($)

PVIF

PV ($)

1

2569000

0.865469365

2223391

2

3220000

0.749037221

2411900

3

3220000

0.648269768

2087425

4

3220000

0.561056759

1806603

5

3220000

0.485577437

1563559

6

3220000

0.420252396

1353213

7

3220000

0.363715574

1171164

8

3220000

0.314784687

1013607

9

3220000

0.272436503

877246

10

3220000

0.235785447

759229

11

3220000

0.204065081

657090

12

3220000

0.176612076

568691

13

3220000

0.152852341

492185

14

3220000

0.132289019

425971

15

3220000

0.114492093

368665

16

3220000

0.099089399

319068

17

3220000

0.085758839

276143

18

3220000

0.074221648

238994

19

3220000

0.064236563

206842

20

3220000

0.055594777

179015

Year 1:96%

Year 11:39%

Year 2:91%

Year 12:33%

Year 3:85%

Year 13:29%

Year 4:79%

Year 14:26%

Year 5:74%

Year 15:23%

Year 6:68%

Year 16:20%

Year 7:62%

Year 17:18%

Year 8:56%

Year 18:1     5%

Year 9:50%

Year 19:13%

Year 10:45%

Year 20:12%

Explanation / Answer

1) Risk Adjusted Discount Rate model ( In $)

2) Certain Equivalent Approach

Present value Factor@ 15.54424

)

3)

Year Cash flows Present Value Factor Present Value of Cash flows 1 25,69,000 0.833026224 21,40,044.37    2 to 20 32,20,000 4.02676158                                129,66,172.29 Total of Inflows                                151,06,216.66 Less: Initial Investment                                190,00,000.00 Net present Value                                 -38,93,783.34   

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