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You are a consultant to a firm evaluating an expansion of its current business.

ID: 2753610 • Letter: Y

Question

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:

On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.8. Assuming that the rate of return available on risk-free investments is 3% and that the expected rate of return on the market portfolio is 11%, what is the net present value of the project? (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places.)

NPV = $ _________

Should the project be accepted? Yes or no

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 CASH FLOW 0 -170 1-10 +15

Explanation / Answer

Cost of Capital = Risk Free Rate + (Market Return - Risk Free Rate)*Beta

= 3 + (11-3)*1.8

= 17.4%

The calculation of NPV is shown below

Present Value of Cash Outflow = $170 million

Present Value of Cash Inflow = $15 million * PVIFA10,17.4%

  = $15 million * 4.591333

= $68.87 million

Net present value (NPV) = Present value of cash inflow - Present value of cash outflow

= $68.87 - $170

= - $101.13 million

As the NPV of the project is negative, it should not be accepted