Question

31. CAPM and Valuation. 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 -100 1-10 +15 On the basis of the behavior of the firm's stock, you believe that the beta of the firm is 1.4. Assuming that the rate of return available on risk-free investments is 4% and that the expected rate of return on the market portfolio is 12%, what is the net present value of the project? (L012-3) 32. CAPM and Cost of Capital. Reconsider the project in Problem 31. (L012-3) a. What is the project IRR? b. What is the cost of capital for the project? c. Does the accept-reject decision using IRR agree with the decision using NPV?

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Α в 31 12% Risk free rate Market rate of return Beta Required rate of return 15.20% Year Cash Flow -$100,000,000.00 $15,000,000.00 $15,000,000.00 $15,000,000.00 $15,000,000.00 $15,000,000.00 $15,000,000.00 $15,000,000.00 $15,000,000.00 $15,000,000.00 $15,000,000.00 8 Net present value of Project -$25.288.816.79 34 8.14% 15.20% IRR of Project Cost of capital for the project Does the accept-reject decision using IRR agree with the decision using NPV YES

Cell reference -

A 2 0.04 31 Risk free rate Market rate of return 12 Beta Required rate of return =C2+C4*(C3-C2) Year Cash Flow 8 9 lo 1 5 - 100000000 15000000 15000000 15000000 15000000 15000000 15000000 15000000 15000000 15000000 15000000 Net present value of Project =C8+NPV(C5,C9:C18) 23 34 IRR of Project 24 Cost of capital for the project =IRR(C8:C18) =C5 YES Does the accept-reject decision using IRR agree with the decision using NPV 25 26 27

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.