You are a consultant to a firm evaluating an expansion of its current business.
ID: 2798500 • 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 1.6. Assuming that the rate of return available on risk-free investments is 8% and that the expected rate of return on the market portfolio is 10%, 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$
Yes
No
Years Cash Flow 0 220 1–10 +20On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.6. Assuming that the rate of return available on risk-free investments is 8% and that the expected rate of return on the market portfolio is 10%, 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
No
Explanation / Answer
i)
First we need to find the cost of capital.
We can use CAPM model
cost of capital = Rf + beta(Rm - Rf)
Rf = risk free rate
Rm = return on market portfolio
cost of capital = 0.08 + 1.6 * (0.1 - 0.08)
= 0.112 = 11.2%
Now we need to find the NPV using the rate as 11.2%
We can use the financial calculator
Press CF then Press 2nd then press CLR Work
Now input the values
CFO = - 220 , Press enter and then press down arrow
Note CF0 is negetive as it is an outlay
CF1 = 20 , Press enter and then press down arrow
F01 = 10 , Press enter
Now Press NPV
Input I = 11.2 Press enter and then press down arrow
NPV gets reflected
Now press CPT
We get NPV as -103.19
ii)
Since the NPV is negetive the project should not be accepted.
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