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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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