Mayflower Interiors is considering investing in one of three mutually exclusive projects, X, Y, and Z. The firm’s cost of capital, r, is 13.5% and the risk-free rate, RF, is 10%. The firm has gathered the basic cash flow and risk index data for each project as shown in the following table.

a. Find the net present value (NPV) of each project, using the firm’s cost of capital.
Which project is preferred in this situation?

b. The firm uses the following equation to determine the risk-adjusted discount rate, RADRj for each project j:

Substitute each project’s risk index into this equation to determine its RADR.

c. Use the RADR for each project to determine its risk-adjusted NPV. Which project is preferable in this situation?

d. Based on your answers in parts a and c, which project should the firm accept?
Explain your answer.

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Initial investment (CFO) Year (t) 1 2 3 4 Risk index (RI) X -$16,500 Project (j) Y - $13,000 Cash inflows (CF) $6,500 4,500 5,200 2,200 1.00 $5,500 5,500 5,500 5,500 1.70 Z - $21,000 $ 5,000 6,500 7,500 11,500 0.40