Biopharma is a pharmaceutical company. Biopharma’s annual stock returns have a C

Question

Biopharma is a pharmaceutical company. Biopharma’s annual stock returns have a CAPM beta of 1.25 (i.e. =1.25). The market portfolio’s return is 13%, and the riskfree rate is 5%. a. What is the required expected return for Biopharma according to the CAPM? b. The firm has the opportunity to develop a new drug. This project requires initial outlay of $400,000 and will bring expected revenue of $100,000 in each of the next 6 years. The riskiness of this project is the same as the overall riskiness of Biopharma. Should the management team of Biopharma approve the project or not and why?

Explanation / Answer

a)

Expected return = Rf+×Rp

= 5%+1.25×(13%-5%)

= 15%

b)

Return on project:

= $100,000÷$400,000

= 25%

Since, return on projects is higher than the expected return, project should be accepted.

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