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Q. Evaluate of Risk-Adjusted Discount Rate?
Illustration: - From the following date state which project is preferable:
Year
Project A
Project B
1
60000
2
50000
3
40000
Initial Cost of the Project1
120000
Riskless discount rate is 5%. Project A is fewer risky as compared to project B and therefore the management considers risk premium rates at 5% and 10% respectively as appropriate for discounting the cash inflow. The discount factors at 10% and 15% are given below
10%
15%
0.909
0.876
0.826
0.756
0.751
0.650
Solution :-
First Step :- Computation of Risk-Adjusted Discount Rate
For Project A:
Riskless Discount Rate 5%
And Risk-Premium Rate 5%
Risk Adjusted Discount Rate 10%
For Project B:
And Risk-Premium Rate 10%
Risk Adjusted Discount Rate 15%
Second Step: - Computation of Discounted Cash Inflows (that is Present Value and Net Present Value of the Projects)
Project A Discounted Cash Inflows at 10%
Cash Inflows (Rs)
Discount Factor 10%
Present Value (Rs.) (Cash Inflow x Discount Factor)
Discount Factor 15%
.909
54540
80000
.876
70080
.826
41300
.756
45360
.751
30040
.650
32500
PV of Cash Inflow 125880 147940
Less: PV of Cash Outflow 120000 120000
Net Present Value 5880 27940
Comments: - The Net Present Value of Project B is superior to that of Project A. Therefore Project B is Preferable.
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