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 millions of dollars) Years from Now After-Tax CF 35 1-9 14 10 The project's beta is 1.9. Assuming rf 6% and E( 16%. 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. Net present value On 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

return = risk free rate+beta*(market return - risk free rate)

= 6%+1.9(16-6) = 6+19 = 25%. Discount factor = 1+rate of return = 1+25% = 1.25

NPV = $16.49 million.

b. Let maximum beta be "b". rate of return = 6%+b(16-6) = 6%+10b.

Using solver to find the discount factor at which NPV becomes 0 (before it becomes negative) in excel:

Thus rate = 1.39 - 1 = 39%

6%+10b = 39

10b = 33

or b = 3.3. Thus maximum possible beta = 3.3

Year Cash flow Discount factor PV 0 -35 1.25 -35.00 1 14 11.20 2 14 8.96 3 14 7.17 4 14 5.73 5 14 4.59 6 14 3.67 7 14 2.94 8 14 2.35 9 14 1.88 10 28 3.01 NPV 16.49

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