Capital Budgeting Decisions A college intern working at Anderson Paints evaluated potential investments using the firm’s average required rate of return (r) as the discount rate in the evaluation...

Capital Budgeting Decisions

A college intern working at Anderson Paints evaluated potential investments using the firm’s average required rate of return (r) as the discount rate in the evaluation process and he produced the following report for you as the capital budgeting manager at Anderson Paints:

Project                         NPV                IRR                 Risk

LOM                           $1,500             12.5%              High

QUE                            0                      11.0                 Low

YUP                           (800)               10.0                 Average

DOG                          (150)               9.5                   Low

As the capital investment manager you must account for the risks associated with capital budgeting projects before making final recommendations and decisions. The company’s capital investment risk management policy calls for an adjustment of the firm’s average required rate of return by plus/minus 2% if a project’s risk deviates from the firm’s average risk classification. The table above shows the estimated profitability of each project using the average required rate of return of the company and disregarding any deviation of each project’s risk from the firm’s average.

Your job as the capital investment manager is to account for differences in risk in each project according to company’s policy and to make recommendations regarding the acceptability or non-acceptability of each potential investment as part of the upcoming proposed firm’s capital budget.

• First, explain how you would adjust each project’s required rate of return for risk using the risk management policy of the company and discuss the appropriateness of the firm’s risk management policy.


• Second, insert a column in the table above showing the appropriate risk-adjusted required rate of return or discount rate for each project.


• Third, explain which of the projects listed above you would recommend and why for the upcoming firm’s capital investment budget.