You are a consultant to a large manufacturing corporation considering a project

Question

You are a consultant to a large manufacturing corporation considering a project with the following net after- tax cash flows (in millions of dollars): The projects beta is 19. Assuming rf= 4% and E(rM) = 14%. a. What is the net present value of the project? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) b. What is the highest possible beta estimate for the project before its NPV becomes negative? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Highest possible beta value

Explanation / Answer

a)

We first need to calculate COst of capital

Cost of capital = Rf + (Rm -Rf ) x beta

= 4% + (14%-4%)x1.9

=23%

Now to calculate NPV, we need to discount all the cash flows at this rate:

NPV = 28.88 million

b)

To find the highest possible beta for the project for ints NPV to become zero, we first need to calculate IRR. IRR is the rate of return at which NPV is zero. we can use IRR function in excel to compute IRR. I have got 49.55% as IRR. Now we can use CAPm equation to estimate beta.

Cost of capital = Rf + (Rm -Rf ) xbeta

49.55 = 4% + (14%-4%)xbeta

subtracting 4% both sides, we get:

45.55% = 10% x beta

dividing both sides by 10%, we get:

Beta =4.56

Year CF PV Factor @ 23% PV 0 -30 1.000 -30.00 1 15 0.813 12.20 2 15 0.661 9.91 3 15 0.537 8.06 4 15 0.437 6.55 5 15 0.355 5.33 6 15 0.289 4.33 7 15 0.235 3.52 8 15 0.191 2.86 9 15 0.155 2.33 10 30 0.126 3.79 28.88

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