Table 12.3
Tangshan Mining Company is considering investment in one of two mutually exclusive projects M and N which are described below. Tangshan Mining's overall cost of capital is 15 percent, the market return is 15 percent and the risk-free rate is 5 percent. Tangshan estimates that the beta for project M is 1.20 and the beta for project N is 1.40.
-Using the risk-adjusted discount rate method of project evaluation, the NPV for project N is ________. (See Table 12.3)

Question

Table 12.3
Tangshan Mining Company is considering investment in one of two mutually exclusive projects M and N which are described below. Tangshan Mining's overall cost of capital is 15 percent, the market return is 15 percent and the risk-free rate is 5 percent. Tangshan estimates that the beta for project M is 1.20 and the beta for project N is 1.40. 
-Using the risk-adjusted discount rate method of project evaluation, the NPV for project N is ________. (See Table 12.3)

Quizplus · Accepted Answer

To calculate the risk-adjusted discount rate, we need to use the following formula:

Risk-adjusted discount rate = Risk-free rate + Beta x (Market return - Risk-free rate)

For project M:
Risk-adjusted discount rate = 5% + 1.20 x (15% - 5%) = 17%

For project N:
Risk-adjusted discount rate = 5% + 1.40 x (15% - 5%) = 19%

Next, we calculate the NPV for each project using the risk-adjusted discount rate:

NPV(M) = -$500,000 + ($200,000 / 1.17) + ($200,000 / 1.17^2) + ($200,000 / 1.17^3) + ($200,000 / 1.17^4) = $13,394.94

NPV(N) = -$500,000 + ($250,000 / 1.19) + ($250,000 / 1.19^2) + ($250,000 / 1.19^3) + ($250,000 / 1.19^4) = $85,732.07

Therefore, the correct answer is (C) $85,732.

Table 12.3 Tangshan Mining Company Is Considering Investment in One of Two