Risk Category Discount Rate

Low risk $($equipment repair$)5\%$

Low to moderate $($new equipment$)7\%$

Moderate risk $($expansion of product line$)10\%$

Moderate to high risk $($new product in domestic market$)13\%$

High Risk $($produce an established produce in a foreign market$)17\%$

Very High Risk $($Produce a new product in a foreign market$)20\%$ Currently, Conestoga International Inc. is deciding on whether to pursue two projects. Both projects

require a $$200,000$ investment in equipment. Additional details about each project is below:.

$$ Project A: Introduce New Product in Domestic Market

o Discount rate $13\%$ based on Figure $1$

o Working capital requirements of $$20,000$ to operationally support the project

$$ Project B: Introduction of a well established in foreign market o $17\%$ discount rate based on Figure $1$

o Working capital requirements of $$15,000$ to operationally support the project The cash flows from Project A and Project B are outlined in Figure $2$ Below:

Figure $2$

Year Project A Project B

$1$ $$45,00055,000$

$260,00065,000$

$390,00095,000$

$4125,000135,000$

$5150,000165,000.$ Requirements

$1.$ Calculate the payback period for both projects. Which project would you select using payback

period as the only methodology of project selection? Can the payback period be an indicator of

risk? If so$,$ how? If not, why not?

$2.$ Compute the Present value of the two projects based on a discount rate of $10\%.$ Which of the

two should Conestoga International Inc. select? Why?

$3.$ Compute the present value of the two projects based on the risk$-$adjusted discount rate. Which

project should Conestoga International select using this approach? Why?

$4.$ Do you think a $5-$year time horizon is appropriate for evaluating Project A or Project B$?$ Why or

why not?

$5.$ Figure $1$ indicates that foreign markets should carry a high discount rate because they are

riskier. However, you remember that diversification can reduce risk. Thus, you begin to wonder

if you have miscategorized the rankings in Figure $1.$ In a single paragraph, comment on whether

the original rankings in Figure $1$ are correct, or if you should redo the risk$-$adjusted discount rate

analysis with revised rankings and why $($Note: Do not recalculate the present value in part $3$