P 12-12 Risk-adjusted rates of return using CAPM

CentennialCatering, Inc., is considering two mutually exclusive investments. The company wishes to use aCAPM-type risk-adjusted discount rate(RADR) in its analysis.Centennial's managers believe that the appropriate market rate of return is 11.5 %, and they observe that the currentrisk-free rate of return is 6.7 %. Cash flows associated with the two projects are shown in the following table.(Click on the icon located on thetop-right corner of the data table below in order to copy its contents into aspreadsheet.)

Project X Project Y

Initial investment (CF 0) $72,000 $76,000

Year (t) Cash inflows (CFt)

1 $26,000 $22,000

2 26,000 34,000

3 26,000 34,000

4 26,000 44,000

a. Use a risk-adjusted discount rate approach to calculate the net present value of eachproject, given that project X has an RADR factor of 1.22 and project Y has an RADR factor of 1.37. The RADR factors are similar to project betas.

(Hint: Use the following equation to calculate the required project return foreach: r equals Upper R Subscript Upper F plus b times left parenthesis r Subscript m minus Upper R Subscript Upper F right parenthesis r=RF+brmRF.)

b. Discuss your findings in part (a), and recommend the preferred project.