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 1.9. Assuming rf = 6% and E(rM) = 16% a. What is the net present value of the project? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) Net present value million b. 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.) Highest possible beta value

Explanation / Answer

rate of return = risk free rate+beta*(market return - risk free rate)

6%+1.9*(16%-6%) = 6%+19% = 25%

This rate will be used for discounting all the cash flows. The discounting factor will be 1.25

Present value = amount/discounting factor^time

NPV = $16.49 million.

Let the beta be "b". so, discount rate = 6%+b(16-6) = 6+10b

We make a model in excel and solve it using solver to get an NPV of 0. The model is solved using solver function.

Thus at discount factor of 1.39, NPV is 0. Rate = 1.39 -1 = 0.39 or 39%.

Now, 6+10b = 39%

10b = 33%. or b = 3.3

This is the maximum posisible beta value, before NPV becomes negative.

Year Cash flow Discount factor PV 0 -35 1.25 -35.00 1 14 11.20 2 14 8.96 3 14 7.17 4 14 5.73 5 14 4.59 6 14 3.67 7 14 2.94 8 14 2.35 9 14 1.88 10 28 3.01 NPV 16.49

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.