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 1.38. Assume that the rate of return available on risk-free investments is 7% and that the expected rate of return on the market portfolio is 15%.

What is the project IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

What is the cost of capital for the project? (Do not round intermediate calculations. Enter your answer as a percent rounded 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

2)

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

=7+1.38*(15-7)

=18.04%

3. Reject project because IRR is less than cost of capital

IRR= 12.415% Year 0 1 2 3 4 5 6 7 8 9 10 Cash flow stream -100 18 18 18 18 18 18 18 18 18 18 Discounting factor 1 1.124148 1.263709 1.420597 1.596961 1.795221 2.018095 2.268638 2.550285 2.866899 3.22282 Discounted cash flows project -100 16.01212 14.24378 12.67073 11.27141 10.02662 8.919303 7.934276 7.058033 6.278561 5.585171 NPV = Sum of discounted cash flows NPV = 0.00 Discounting factor = (1 + discount rate)^(CORRESPONDING PERIOD IN YEARS) Discounted Cashflow= Cash flow stream/discounting factor

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