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

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:

a. On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.7. Assuming that the rate of return available on risk-free investments is 5% and that the expected rate of return on the market portfolio is 12%, 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 = $___________

b. Should the project be accepted? Yes or No?

Years Cash Flow 0 -300 1-10 80

Explanation / Answer

The project should be accepted since it has a possitive NPV.

Year Cash Flow PV Factor = 1/(1+R)^n Present Value = Cash Flow * PV factor 0 ($300) 1.00000 ($300.00) 1 $80 0.892857 $71.43 2 $80 0.797194 $63.78 3 $80 0.711780 $56.94 4 $80 0.635518 $50.84 5 $80 0.567427 $45.39 6 $80 0.506631 $40.53 7 $80 0.452349 $36.19 8 $80 0.403883 $32.31 9 $80 0.360610 $28.85 10 $80 0.321973 $25.76 Sum of Present Value $452.02 Net Present value = Total PV - Intial Investment $152.02

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