Problem:
(Risk-adjusted discount rates and risk classes) The G. Wolfe Corporation is examining two capital-budgeting projects with 5-year lives. The first, 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 uses a required rate of return or discount rate that has been pre-assigned to that purpose or risk class. The expected cash flows for these projects are given here:
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|
PROJECT A
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PROJECT B
|
|
Initial investment
|
-$250,000
|
-$400,000
|
|
Cash inflows:
|
|
|
|
Year 1
|
$ 30,000
|
$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 pre-assigned required rates of return are as follows:
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PURPOSE
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REQUIRED RATE OF RETURN
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|
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.