(Risk- adjusted discount rates and risk classes) The G. Wolfe Corporation is exa
ID: 2765997 • Letter: #
Question
(Risk- adjusted discount rates and risk classes) The G. Wolfe Corporation is examining two capital-budgeting projects with 5-year lives. The firs, project A, is a replacement project; the second, project B, is a project unrelated to current operations. The G. Wolfe Corporation uses the risk-adjusted discount rate method and groups projects according to purpose, and then it uses a required rate of return or discount rate that has been preassigned to that purpose, and then it users a required rate of return or discount rate that has been preassigned to that purpose or risk class. The expected cash flows for these projects are given here:
Project A
Project B
Initial investment
-$250,000
-$400,000
Cash inflows:
Year 1
$130,000
$135,000
Year 2
40,000
135,000
Year 3
50,000
135,000
Year 4
90,000
135,000
Year 5
130,000
135,000
The purpose/risk classes and preassigned required rates of return are as follows:
Purpose
Required rate of return
Replacement decision
12%
Modification or expansion of existing product line
15
Project unrelated to current operations
18
Research and development operations
20
Determine each project’s risk-adjusted net present value.
Project A
Project B
Initial investment
-$250,000
-$400,000
Cash inflows:
Year 1
$130,000
$135,000
Year 2
40,000
135,000
Year 3
50,000
135,000
Year 4
90,000
135,000
Year 5
130,000
135,000
Explanation / Answer
G.Wolfe Corporation All Amounts in $ For Project A, the required rate of return as per the table is 12% For Project B, the required rate of return as per the table is 18% Given the information pertaining to the cash inflows and outflows, and the rate of return The risk adjusted Net Present Value for Project A will be $ 41,665.67 The risk adjusted Net Present Value for Project B will be $ 18,786.52
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