You are a consultant to a firm evaluating an expansion of its current business.

Question

You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows:

On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.8. Assuming that the rate of return available on risk-free investments is 3% and that the expected rate of return on the market portfolio is 11%, what is the net present value of the project? (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places.)

You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows:

Explanation / Answer

Required rate of return=Risk free rate+Beta(Market rate of return-Risk free rate)=3%+1.8(11%-3%)=17.4%

NPV of the project=Pv of cash inflow-Pv of cash outflow

=$15 million*present value of annual factors for 10 years @17.4%-$170

present value of annual factors for 10 years @17.4%=1/1.174+1/1.1742+1/1.1743.........+1/1.17410=4.5916

so NPV=4.5916*$15 million-$170 million=$68.8744 Million-$170 million=-$101.1256 million

b.

The project should not supposed to be accept, because the NPV is negative.

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