You are a consultant to a mid-sized manufacturing corporation that is considerin

Question

You are a consultant to a mid-sized manufacturing corporation that is considering an investment project. The project requires an initial investment of $100 million and will generate an after tax cash of $25 million every year in perpetuity. The project’s beta is 2. Assuming that rf = 6% and E (rm) = 15%.

What is the net present value of the project?

E(rProject) = rf + (E(rM) – rf)

E(rProject) = 6% + 2 (15% - 6%)

E(rProject) = .06 + 2 (.15 - .06)

E(rProject) = .06 + 2 (.09)

E(rProject) = .06 + .18

E(rProject) = .24 x 100 = 24%

PV = $25,000,000/.24 = $104,166,667

NPV = PV – I

NPV = $104,166,667 - $100,000,000 = $4,166,667

What is the highest possible beta estimate for the project before its NPV becomes negative?

I = $100,000,000

CF = $25,000,000

IRR = 25%

= [E(rProject) - rf ] / (E(rM) – rf)

= (25% - 6%) / (15% – 6%)

= (.25 - .06) / (.15 – .06)

= .19 / .09 = 2.11

How do you get an IRR of 25%. Show me what needs to be plugged on TI BA II Plus to get this percentage.

Explanation / Answer

As it is perpetual cash flows, present value of cash inflows will be equal to cash flow/rate of return

At IRR, NPV will be equal to zero

Hence, -100+25/IRR=0

=>IRR=25/100=25%

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