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: Years Cash Flow 0 110 1–10 +10 a. On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.2. 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 10%, 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 No

Explanation / Answer

Answer:

Expected rate of return = Risk free rate + Beta* Market risk premium

                                           = 3+1.2*(10-3)

                                           = 11.40%

Now,

Net present value of project = Present value of inflow – Present value of outflow

                                                     = 10*5.792 – 110

                                                      = -$52.08

The project should not be accepted due to negative net present cashflow.

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

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