CAPM and valuation you are a consultant to a firm evaluating an expansion of its

Question

CAPM and valuation you are a consultant to a firm evaluating an expansion of its current business. The cash-flows forecasts (in millions of dollars) for the project are as follows Years 0,1-10 Cash Flow -100, +15. on the basis of the behavior of the firms stock, you believe that the beta of the firm is 1.4. Assuming that the rate of return available on risk-free investments is 4 percent and that the expected rate of return on the market portfolio is 12 percent, what is the net present value of the project?

Explanation / Answer

Using CAPM, the expected rate of return = Risk free rate + Beta * (Expected market return - risk free rate) = 4 + 1.4*(12-4) = 15.2% Discounting the cash flows using the expected rate of return, Net present value = -100 + 15 / (1+0.152) + 15 / (1+0.152)^2 + ... + 15 /(1+0.152)^10 = -$25.29

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