You are a consultant to a firm evaluating an expansion of its current business.
ID: 2770318 • 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 1.4. Assuming that the rate of return available on risk-free investments is 5% and that the expected rate of return on the market portfolio is 12%, 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.)
Years Cash Flow 0 130 1–10 +20Explanation / Answer
a)
Required rate of return = 5% + 1.4 (12% - 5%) = 14.8%
NPV at the 14.80% discount rate = 20 m * PVIFA(14.8% , 10) - 130 M = 20m * 5.0573 - 130m = - $28.85 m
NPV = - $28.85 million
b. No, we should not accept the project.
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