5. Risk-adjusted discount rate approach Aa AaE justed discount rate (RADR) appro

Question

5. Risk-adjusted discount rate approach Aa AaE justed discount rate (RADR) approach recognizes that diferent Investment projects exhibit diferent risk profies. Moreover, based on the risk profie of an individual project, the rate of return used to discount the project's expected cash fiows can be adjusted to accommodate the specfic riskiness of that specific project. This generally involves adding a project-specific risk premium to the market's risk-free rate to adjust the discount rate used to discount the proposed project's expected future cash flows and determine the project's expected net present value. In your role as a financial analyst, you've been tasked with evaluating your company's investment that a specific investment project exhibits lower risk than the average risk of the firm's other projects, then you would want to use a discount rate that is value (NPV) projects. If you believe than the firm's average cost of capital when computing the project's net present Consider the case of Green Zebra Media Company: Green Zebra Media Company is owned 100% by private shareholders and carries no debt on its books. The company's beta is estimated to be 1.0. The company uses a risk-free rate of 9%, and the market expects a return of 13%. The graph below plots the security market line the risk-adjusted discount rate approach toward project risk, plot the following points on the graph: . Use point A (orange square) to show the rate of return the company should require on a project with average risk. (SMLJ. Based on your understanding of the capital asset pricing model and Use point B (green triangle) to the rate of return the company should require on a project with a beta of 0.80. Tool tip: Mouse over the points on the graph to see their coordinates REQUIRED RATE OF RETURN [Percent 20 18 16 14 12 10 0.0 02 04 04 0.8 10 12 14 16 1.8 20 PROJECT BETA Suppose the company is analyzing a project that requires a net investment of $6.0 million. The project looks very promising

Explanation / Answer

lower

average riks required return=9%+1*(13%-9%)=13%
NPV=-6+18/1.13+18/1.13^2+18/1.13^3+18/1.13^4+18/1.13^5=57.31 million

lower risk required return=9%+0.8*(13%-9%)=12.2%
NPV=-6+18/1.122+18/1.122^2+18/1.122^3+18/1.122^4+18/1.122^5=58.57 million

Related Questions

Navigate

• Browse (All)
• Browse 5
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.