3 the results clearly show that project b in

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Unformatted text preview: value of each project, calculated using its RADR, is found as shown on the time lines in Figure 10.3. The results clearly show that project B in preferable, because its risk-adjusted NPV of $9,798 is greater than the $6,063 risk-adjusted NPV for project A. As reflected by the NPVs in part B of Table 10.1, if the discount rates were not adjusted for risk, project A would be preferred to project B. Calculator Use We can again use the preprogrammed NPV function in a financial calculator to simplify the NPV calculation. The keystrokes for project A— the annuity—typically are as shown at the top of the next page. The keystrokes for project B—the mixed stream—are also shown at the top of the next page. CHAPTER 10 Risk and Refinements in Capital Budgeting 437 The calculated NPVs for projects A and B of $6,063 and $9,798, respectively, agree with those shown in Figure 10.3. Project A Input 42000 Project B Function CF0 Input 45000 Function CF0 14000 CF1 28000 CF1 5 N 12000 CF2 14 I 10000 CF3 NPV 3 N 11 Solution 6063.13 I NPV Solution 9798.43 FIGURE 10.3 Calculation of NPVs for Bennett Company’s Capital Expenditure Alternatives using RADRs Time lines depicting the cash flows and NPV calculations using RADRs for projects A and B Project A 0 $42,000 End of Year 1 2 3 4 5 $14,000 $14,000 $14,000 $14,000 $14,000 k = 14% 48,063 NPVA = $ 6,063 Project B 0 $45,000 25,225 9,739 $54,798 7,312 6,587 5,935 End of Year 1 $28,000 k = 11% 2 3 4 5 $12,000 $10,000 $10,000 $10,000 k = 11% k = 11% k = 11% k = 11% NPVB = $ 9,798 Note: When we use the risk indexes of 1.6 and 1.0 for projects A and B, respectively, along with the table in the middle of the preceding page, a risk-adjusted discount rate (RADR) of 14% results for project A and a RADR of 11% results for project B. 438 PART 3 Long-Term Investment Decisions Spreadsheet Use Analysis of projects using risk-adjusted discount rates (RADRs) also can be calculated as shown on the following Excel spreadsheet. The usefulness of risk-adjusted discount rates should now be clear. The real difficulty lies in estimating proj...
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