Risk-adjusted rates of return using CAPMCentennial Catering, Inc., is considering two mutually exclusive investments. The...
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Risk-adjusted rates of return using CAPMCentennial Catering, Inc., is considering two mutually exclusive investments. The company wishes to use a CAPM-type risk-adjusted discount rate (RADR) in its analysis. Centennial's managers believe that the appropriate market rate of return is 11.7%, and they observe that the current risk-free rate of return is 6.9%. Cash flows associated with the two projects are shown in the following table.
Project X
Project Y
Initial investment
(CF0)
$75,000
$78,000
Year
(t )
Cash inflows
(CFt)
1
$33,000
$17,000
2
33,000
35,000
3
33,000
40,000
4
33,000
43,000
a. Use a risk-adjusted discount rate approach to calculate the net present value of each project, given that project X has an RADR factor of 1.19 and project Y has an RADR factor of 1.43. The RADR factors are similar to project betas. (Hint: Use the following equation to calculate the required project return for each: r=RF+brmRF.)
b. Discuss your findings in part (a), and recommend the preferred project.
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