A firm is considering investment in a capital project which is described below. The firm's cost of capital is 18 percent and the riskfree rate is 6 percent. The project has a risk index of 1.5. The firm uses the following equation to determine the risk adjusted discount rate, RADR, for each project: RADR = Rf + Risk Index (Cost of capital - Rf)
$$\begin{array} { l r }
\text { Initial Investment } & \$ 1,000,000 \
\hline \text { Year } & \text { Cash Inflow } \
\hline 1 & \$ 500,000 \
2 & 500,000 \
3 & 500,000
\end{array}$$
-The discount rate that should be used in the net present value calculation to compensate for risk is(See Figure 13.3)
A) 24 percent.
B) 18 percent.
C) 15 percent.
D) 6 percent.

Question

A firm is considering investment in a capital project which is described below.  The firm's cost of capital is 18 percent and the riskfree rate is 6 percent.  The project has a risk index of 1.5.  The firm uses the following equation to determine the risk adjusted discount rate, RADR, for each project:   RADR = Rf + Risk Index (Cost of capital - Rf)
$$\begin{array} { l r } 
\text { Initial Investment } & \$ 1,000,000 \
\hline \text { Year } & \text { Cash Inflow } \
\hline 1 & \$ 500,000 \
2 & 500,000 \
3 & 500,000
\end{array}$$
-The discount rate that should be used in the net present value calculation to compensate for risk is(See Figure 13.3)
A) 24 percent.
B) 18 percent.
C) 15 percent.
D) 6 percent.

Quizplus · Accepted Answer

The RADR is calculated as follows: RADR = 6% + 1.5 * (18% - 6%) = 6% + 18% = 24%.

A Firm Is Considering Investment in a Capital Project Which