(Risk-adjusted discount rates and risk classes)
The G. Wolf Corporation is examining two capital-budgeting projects with five 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 according to purpose and then uses a required rate of return or discount rate that has been pre-assigned projects to that purpose or risk class.
The expected cash flows for these projects are as follows:
Project A Project B
Initial investment Cash Flow $250,000 $400,000
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 or risk classes and pre-assigned 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
Determiner the project's risk-adjusted net present value.
Calculation of Risk adjusted net present value:
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