The Oneonta Chemical Company Is Evaluating Two Mutually Exclusive Pollution

question 25

Multiple Choice

The Oneonta Chemical Company is evaluating two mutually exclusive pollution control systems.Since the company's revenue stream will not be affected by the choice of control systems, the projects are being evaluated by finding the PV of each set of costs.The firm's required rate of return is 13 percent, and it adds or subtracts 3 percentage points to adjust for project risk differences.System A is judged to be a high-risk project (it might end up costing much more to operate than is expected) .The appropriate risk-adjusted discount rate that should be used to evaluate System A is

• A)10%; this might seem illogical at first, but it correctly adjusts for risk where outflows, rather than inflows, are being discounted.
• B)13%; the firm's cost of capital should not be adjusted when evaluating outflow only projects.
• C)16%; since A is more risky, its cash flows should be discounted at a higher rate, because this correctly penalizes the project for its high risk.
• D)Somewhere between 10% and 16%, with the answer depending on the riskiness of the relevant inflows.
• E)Indeterminate, or, more accurately, irrelevant, because for such projects we would simply select the process that meets the requirements with the lowest required investment.

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