Risk-adjusted rates of return using CAPM

Centennial Catering, Inc., is considering two mutually exclusive investments. The company wishes to use a CAPM-type risk-adjusted discount rate (RADR) in its analysis. Centennial's managers believe that the appropriate market rate of return is 11.6%, and they observe that the current risk-free rate of return is

7.5%. Cash flows associated with the two projects are shown in the following table

	Project X	Project Y
Initial investment (CF0)	$70,000	$82,000
Year (t )	Cash inflows (CFt)
1	$35,000	$18,000
2	35,000	35,000
3	35,000	38,000
4	35,000	50,000

a. Use a risk-adjusted discount rate approach to calculate the net present value of each project, given that project X has an RADR factor of 1.19 and project Y has an RADR factor of 1.44. The RADR factors are similar to project betas.

(Hint: Use the following equation to calculate the required project return for each: r=RF+brmRF.)

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