You are a consultant to a large manufacturing corporation considering a project

Question

You are a consultant to a large manufacturing corporation considering a project with the following net after-tax cash flows (in millions of dollars):

The project's beta is 1.8. Assuming rf = 4% and E(rM) = 14%.

What is the net present value of the project? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

What is the highest possible beta estimate for the project before its NPV becomes negative? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

You are a consultant to a large manufacturing corporation considering a project with the following net after-tax cash flows (in millions of dollars):

Explanation / Answer

a. First we need to find the Discount rate, i.e., Cost of Equity(Ke). Ke will be calculated using CAPM model.

Ke = Rf + (Rm - Rf) x Beta = 4 + (14 - 4) x 1.80 = 22%

NPV = -39 + 15 x PVAF(22%, 9 years) + 30 x PVF(22%, 10 year) = $21.90 million

b. We need IRR for this. We can get IRR using excel formula: =IRR(-39to30,22%)

By this we will get IRR of 37.46%. Thus, after this NPV starts becoming negative. Thus, applying CAPM now

37.46% = 4 + (14 - 4) x Beta

Thus, Highest Possible Beta before NPV becomes 0(zero) = 3.35

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