Moses Manufacturing is attempting to select the best of three mutually exclusive projects, X, Y, and Z. Although all the projects have 5-year lives, they possess differing degrees of risk. Project X is in class V, the highest-risk class; project Y is in class II, the below-average-risk class; and project Z is in class III, the average-risk class. The basic cash flow data for each project and the risk classes and risk-adjusted discount rates (RADRs) used by the firm are shown in the following tables. Project X Project Y Project Z Initial investment (CF0) $179,000 $235,000 $312,000 Year (t ) Cash inflows (CFt) 1 $80,000 $56,000 $85,000 2 66,000 68,000 85,000 3 62,000 73,000 85,000 4 55,000 84,000 85,000 5 65,000 96,000 85,000 Risk Classes and RADRs Risk Class Description Risk adjusted discount rate (RADR) I Lowest risk 10.6% II Below-average risk 13.7 III Average risk 15.8 IV Above-average risk 19.6 V Highest risk 22.7 a. Find the risk-adjusted NPV for each project. b. Which project, if any, would you recommend that the firm undertake?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter12: Capital Budgeting: Decision Criteria

Section: Chapter Questions

Problem 13P

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Moses Manufacturing is attempting to select the best of three mutually exclusive projects, X, Y, and Z. Although all the projects have

5-year

lives, they possess differing degrees of risk. Project X is in class V, the highest-risk class; project Y is in class II, the below-average-risk class; and project Z is in class III, the average-risk class. The basic cash flow data for each project and the risk classes and risk-adjusted discount rates (RADRs) used by the firm are shown in the following tables.

	Project X	Project Y	Project Z
Initial investment (CF0)	$179,000	$235,000	$312,000
Year (t )	Cash inflows (CFt)
1	$80,000	$56,000	$85,000
2	66,000	68,000	85,000
3	62,000	73,000	85,000
4	55,000	84,000	85,000
5	65,000	96,000	85,000

Risk Classes and RADRs
Risk Class	Description	Risk adjusted discount rate (RADR)
I	Lowest risk	10.6%
II	Below-average risk	13.7
III	Average risk	15.8
IV	Above-average risk	19.6
V	Highest risk	22.7

a. Find the risk-adjusted NPV for each project.

b. Which project, if any, would you recommend that the firm undertake?

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