The Unlimited, a national retailing chain, is considering an investment in one of two mutually exclusive projects. The discount rate used for Project A is 12 percent. Further, Project A costs $15,000, and it would be depreciated using MACRS. It is expected to have an after-tax salvage value of $5,000 at the end of 6 years and to produce after-tax cash flows (including depreciation) of $4,000 for each of the 6 years. Project B costs $14,815 and would also be depreciated using MACRS. B is expected to have a zero salvage value at the end of its 6-year life and to produce after-tax cash flows (including depreciation) of $5,100 each year for 6 years. The Unlimited's marginal tax rate is 40 percent. What risk-adjusted discount rate will equate the NPV of Project B to that of Project A?
A) 15%
B) 16%
C) 18%
D) 20%
E) 12%

Question

Quizplus · Accepted Answer

To equate the NPV of Project B to that of Project A, we need to find the discount rate at which the present value of Project B's cash flows equals the NPV of Project A. Calculating the NPV of Project A using a 12% discount rate and comparing it to Project B's cash flows, the risk-adjusted discount rate that equates the NPVs is approximately 16%.

The Unlimited, a National Retailing Chain, Is Considering an Investment