Question
Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Inc., as Vice-President of Finance.
Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Inc., as Vice-President of Finance. She believes in adjusting projects for risk. Her father is somewhat skeptical but agrees to go along with her. Her approach is somewhat different than the risk-adjusted discount rate approach, but achieves the same objective. She suggests that the inflows for each year of a project be adjusted downward for lack of certainty and then be discounted back at a risk-free rate. The theory is that the adjustment penalty makes the inflows the equivalent of riskless inflows, and therefore a risk-free rate is justified.
A table showing the possible coefficient of variation for an inflow and the associated adjustment factor is shown next:
Coefficient of Variation | Adjustment Factor | ||||
0 | .25 | .90 | |||
.26 | .50 | .80 | |||
.51 | .75 | .70 | |||
.76 | 1.00 | .60 | |||
1.01 | 1.25 | .50 | |||
Assume a $125,000 project provides the following inflows with the associated coefficients of variation for each year.
Year | Inflow | Coefficient of Variation | ||||
1 | $ | 38,700 | .15 | |||
2 | 51,200 | .23 | ||||
3 | 78,200 | .48 | ||||
4 | 58,900 | .75 | ||||
5 | 66,500 | 1.05 | ||||
Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. a. Fill in the table below: (Do not round intermediate calculations. Round your dollar answers to the nearest whole dollar.)
b-1. If the risk-free rate is 6 percent, compute the net present value of the adjusted inflows. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.)
b-2. Should this project be accepted?
No | |
Yes |
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started