Question

You are a consultant to a firm evaluating an expansion of its current business. The annual cash flow forecasts (in millions of dollars) for the project are:

           

Years	Annual Cash Flow
0	-83
1 - 10	14

       

Based on the behaviour of the firm's stock, you believe that the beta of the firm is 1.5. 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? (Round your answer to 2 decimal places.)

Answer 1

Calculation of required rate of return

Required rate of return = Risk free rate + Portfolio beta *[Market return-risk free rate]

Risk free rate =5%

Market return= 12%

Beta = 1.50

Required rate of return = 5+1.50[12-5] = 5+10.50 = 15.50%

Calculation of Net Present value:

Years	Cash flows	Present value factor @15.50%	Discounted cash flow
0	-83	1	-83
1-10	14	4.9246	68.94
			-14.06

Net Present value of the project = -14.06