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 = 5% and E(rM) = 15%.

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

To calculate the Net present value we need to compute the Ke the expected rate of return at which the project to be discounted and hence the formaula for that is

Ke = Rf + beta (Rm- Rf)

Rf = risk free rate

Rm = market return

Expected return = 5% +1.8(15-5)

Discounting rate = 23%

year cashflow discount factor@23% Present value

highest possible beta to be increased so that the NPV becomes zero and to make the npv zero the discounting rate that is the expected rate of return to be increased so that npv becomes zero and do increase the expected return beta needs to be increased.

The rate at which the NPV becomes zero is 40% hence the beta is = 40% = 5% +beta (10%)

35% = X (10%)

therefore X = beta = 3.5

hence that is the highest possible beta extimate before the project NPV becomes negative

The calculation is just trial and error and discounted at 40% is shown below:

Year Cashflow Discounted@40% Present value

Since the net present value is almost zero at 40% hence the possible beta is calculated

Thank you.

0 -34 1 -34.000 1 14 0.813 11.382 2 14 0.661 9.254 3 14 0.537 7.523 4 14 0.437 6.117 5 14 0.355 4.973 6 14 0.289 4.043 7 14 0.235 3.287 8 14 0.191 2.672 9 14 0.155 2.173 10 28 0.126 3.533 Net present value $20.956million

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