Question

Finance Question 14. MZG is considering a project that pays CFs of $3million a year for three years. These cash flows have been adjusted for risks. Given an expected market return of 13%, market risk premium of 9%, and a beta of 1.2, what is the NPV of the project? A. $6.87 million B. $8.32 million C. $6.35 million D. None of the above Answer: B. use risk-free of 4% as discount rate. CFs are certainty equivalent. Using CAPM formula Return = rf + beta ( market premium) 13% = rf + 1.2(9%) rf = 2.2% Why the answer using 4% as the risk free rate? Is thrisk-freeree rate = discount rate?

Answer 1

MZG is considering the project that pays CFs of 3 million a year for 3 years.

These cashflows has been adjusted for risk and the expected market return is 13% with a market risk premium of 9%

Risk free discount rate = 13 - 9 = 4% since we need to deduct the market risk premium from the expected return

Beta comes into play when there is volatility of return and since the cash flows are already adjusted for risk we need not consider beta again.

The NPV of the project = 3/[(1+.04)^1] + 3/[(1+.04)^2] + 3/[(1+.04)^3}

= 2.884 + 2.773 + 2.666 = 8.323

Hence the NPV of the project is 8.323 million $