Question
Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Incorporated, 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 Incorporated, 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 risk-less 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 0.25 | 0.90 |
0.26 0.50 | 0.80 |
0.51 0.75 | 0.70 |
0.76 1.00 | 0.60 |
1.01 1.25 | 0.50 |
Assume a $170,000 project provides the following inflows with the associated coefficients of variation for each year.
Year | Inflow | Coefficient of Variation |
---|---|---|
1 | $ 39,100 | 0.11 |
2 | 56,700 | 0.23 |
3 | 76,600 | 0.43 |
4 | 64,000 | 0.84 |
5 | 67,200 | 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:
Note: 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.
Note: 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?
multiple choice
-
No
-
Yes
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