Question

You are a consultant to a large manufacturing corporation considering a project with the following net after-tax cash flows (in millions of dollars):

Years from Now	After-Tax CF
0	-26
1-9	16
10	32

The project's beta is 1.5. Assuming rf = 6% and E(rM) = 12%

a. What is the net present value of the project? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

Net present value _____ million

b. What is the highest possible beta estimate for the project before its NPV becomes negative? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Highest possible beta value _____

Answer 1

Expected return = Risk free return + beta * Market risk premium

= 6 + 1.5 * (12-6)

= 15 %

Years from Now	After-Tax CF	PVF	PV
0	-26	1	-26
1-9	16	4.771584	76.35
10	32	0.247185	7.91
NET PRESENT VALUE			58.26

To calculate the highest possible ? estimate for a positive NPV, calculate the projects IRR

Use the calculator’s CF register or use Excel:

CF0= -26, CF1-9= 16, N1= 10, IRR = 61.34 %

So the highest ? before the hurdle rate exceeds the IRR is:

E(r) = rf+ ? * [E(rM ) – rf ]

? = [E(r) – rf] / [E(rM ) – rf ]

? = [0.6134 - 0.06]/[0.12 – 0.06]

= 9.22