Question

Firm XYZ usually invests in projects with a risk level of β=0.8. It is considering an investment in a new project which is expected to produce a CF of TZS12.6Mil a year from now, and this CF is expected to grow at a constant rate of 2% per year forever. This CF is only an expectation and the firm’s economist estimates it’s Std to be TZS.3Mil. What is the present value of the CFs of this project, if the expected annual return of the market portfolio is 12%, the annual return of money market instruments is 4% and the market is in equilibrium (CAPM)?

Answer 1

Answer:-

Expected cash flow (CF) = TZS 12.60 million/year

Firm's economist estimate (Standard Deviation) = TZS 0.30 million/year

Growth Rate (g) = 2% forever

Beta = 0.80

Market return (Rm) = 12%

Risk-free rate (Rf) = 4%

Required Rate (Re) = Rf + (Rm-Rf)Beta

Required Rate (Re) = 4% + (12% - 4%)0.80

Required Rate (Re) = 4% + 6.40%

Required Rate (Re) = 10.40%

Present value of CF of project = CF/Re-g

Present value of CF of project = 12.60 / 0.1040 - 0.02

Present value of CF of project = TZS 150 million (Ans.)