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 milllons of dollars): Years from Now After-Tax CF 36 12 24 1-9 10 The projects beta is 1.5. Assuming rr 4% and E(rm) 12% a. What is the net present value of the project? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) Net present value b. 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.) Highest possible beta value millilon

Explanation / Answer

A. First we need to calculate interest rate = risk free rate+beta*(expected market return-risk free rate)

=4+1.5*(12-4)=4+12=16%

NPV= CF0+PV of annuity for period 1 to 9+ CF10/(1+r)^10

=CF0+p*((1-(1+r)^-n)/r+CF10/(1+r)^10

=-36+{12*((1-1.16^-9)/0.16}+24/1.16^10

=-36+(12*4.61)+24/4.4114

=-36+552.279+5.440

=24.72 Million

B. IRR will be the rate before its NPV become negative

we will use Function IRR in excel as =IRR(B3:B13) and you will get 31.91% as result

Now we need to calculate Beta accordingly.

So IRR= Risk free rate+Beta*(expected market return-risk free rate)

31.91= 4+Beta*(12-4)

=31.91=4+Beta*8

=Beta = (31.91-4)/8

Beta =3.49

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