Centennial 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 12%, and they observe that the current risk-free rate of return is 7%. Cash flows associated with the two projects are shown in the following table.
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 1.20 and project Y has
an RADR factor of 1.40. The RADR factors are similar to project betas. (Use
Equation 11.5 to calculate the required project return for each.)
b. Discuss your findings in part a, and recommend the preferred project.