You are a consultant to a firm evaluating an expansion of its current business.
ID: 2753610 • Letter: Y
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.)
NPV = $ _________
Should the project be accepted? Yes or no
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:
YEARS CASH FLOW 0 -170 1-10 +15Explanation / Answer
Cost of Capital = Risk Free Rate + (Market Return - Risk Free Rate)*Beta
= 3 + (11-3)*1.8
= 17.4%
The calculation of NPV is shown below
Present Value of Cash Outflow = $170 million
Present Value of Cash Inflow = $15 million * PVIFA10,17.4%
= $15 million * 4.591333
= $68.87 million
Net present value (NPV) = Present value of cash inflow - Present value of cash outflow
= $68.87 - $170
= - $101.13 million
As the NPV of the project is negative, it should not be accepted
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