Q. Evaluate of Risk-Adjusted Discount Rate?

Illustration: - From the following date state which project is preferable:

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

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:

Riskless Discount Rate                                               5%

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)

Comments: - The Net Present Value of Project B is superior to that of Project A. Therefore Project B is Preferable.