Question

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

Years    Cash Flow

   0 – 100

1–10 + 18

On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.45. Assuming that the rate of return available on risk-free investments is 6% and that the expected rate of return on the market portfolio is 14%, what is the net present value of the project? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions of dollars rounded to 2 decimal places.)

Net present value $ million

Answer 1

Cost of equity using CAPM method = risk free rate + beta ( expected return on market - risk free rate)

cost of equity = 0.06 + 1.45 ( 0.14 - 0.06)

cost of equity =0.176 or 17.6%

NPV = present value of cash inflows - present value of cash outflows

Present value of cash inflows = PMT x ((1 - (1 / (1 + r) ^ n)) / r)

Present value of cash inflows = 18,000,000 * ((1 - ( 1 / ( 1 + 0.176)¹⁰)) / 0.176)

Present value of cash inflows = 18,000,000 * ( 0.802336 / 0.176)

Present value of cash inflows = 18,000,000 * 4.558729

Present value of cash inflows = 82,057,128.01

NPV = 82,057,128.01 - 100,000,000 = -17,942,871.99

Net present value is -17.94 million

NPV = 74,315,038.67 -