question archive Problem 12-31 CAPM and Valuation (LO3) You are a consultant to a firm evaluating an expansion of its current business
Problem 12-31 CAPM and Valuation (LO3) You are a consultant to a firm evaluating an expansion of its current business
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Problem 12-31 CAPM and Valuation (LO3) 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 0 1-10 Cash Flow 100 + 19 On the basis of the behavior of the firm's stock, you believe that the beta of the firm is 1.46. Assuming that the rate of return available on risk-free investments is 4% and that the expected rate of return on the market portfolio is 13%, 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
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According to CAPM :
COST OF EQUITY = RF + (RM-RF)* BETA
WHERE, RF = 4%
MARKET RETURN = 13%
So, Re = 4 + (13 -4)*1.46
= 17.14%
NPV = - CFO/(1+ R)^0 + CF1/(1+R)^1 + CF2/(1+R)^2 + CF3/(1+R)^3 + CF4/(1+R)^4 +
CF5/(1+R)^5 + CF6/(1+R)^6 + CF7/(1+R)^7 + CF8/(1+R)^8 + CF9/(1+R)^9 + CF10/(1+R)^10
= -100/(1.1714)^0 + 19/(1.1714)^1 + 19/(1.1714)^2 + 19/(1.1714)^3 + 19/(1.1714)^4 + 19/(1.1714)^5 + 19/(1.1714)^5 + 19/(1.1714)^6 + 19/(1.1714)^7 +
19/(1.1714)^8 + 19/(1.1714)^9 + 19/(1.1714)^10
= -100 + 16.21991 + 13.8466 + 11.82056 + 10.09097 + 8.61445 + 7.35398 + 6.27794 + 5.35935+ 4.57516 + 3.90572
= -100 + 88.06463
= - 11.93537 (ANSWER)
