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
00.25 0.90
0.260.50 0.80
0.510.75 0.70
0.761.00 0.60
1.011.25 0.50
Assume a $178,000 project provides the following inflows with the associated coefficients of variation for each year.
Year Inflow Coefficient of Variation
1 $36,400 0.16
2 57,100 0.22
3 76,600 0.46
4 56,200 0.79
5 63,600 1.07
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 "Adjustment Factor" answers to 2 decimal places and other answers to the nearest whole dollar.)
|
b-1. If the risk-free rate is 7 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.)
|Net present Value|__________________| b-2. Should this project be accepted?
____Yes
____No
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