Question

A project is determined to have equal probability of generating $3 million annually or $1 million annually for six years. The initial investment is $8 million. The expected return on Treasury bills is 2 percent and the market return is 10 percent. What is the highest project beta that will justify acceptance of the project?

Answer 1

step 1, calculate the IRR

Year	cashflow
0	-8
1	2
2	2
3	2
4	2
5	2
6	2
IRR	13%

Year	cashflow
0	-8
1	=(3*50%)+(1*50%)
2	=(3*50%)+(1*50%)
3	=(3*50%)+(1*50%)
4	=(3*50%)+(1*50%)
5	=(3*50%)+(1*50%)
6	=(3*50%)+(1*50%)
IRR	=IRR(B2:B8,10%)

As per CAPM

Expected Return = Risk free Rate + beta x Market Risk premium

13% = 2% + beta x (10%-2%)

13% = 2% + 8% beta

13%-2% / 8% = beta

Beta =1.375

Therefore, highest project beta that will justify acceptance of the project is 1.375

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