Question

3) A manager is evaluating two projects for investment, with the following betas and cash flows: Project APA = 0.5): 1-0 -$1000 $500 $500 $500 Project B (B8 = 1.5): 1=0 -$1000 $500 $500 $1000 If the risk-free rate is 5% and market return is 10%, which project should the manager invest?

Answer 1

Select the project with higher NPV.

NPV = PV of Cash Inflows - PV of Cash Outflows

Required Rate = Rf + Beta ( Rm - Rf )

Project A:

Required Rate = Rf + Beta ( Rm - Rf )

= 5% + 0.5 (10% - 5%)

= 5% + 0.5 * 5%

= 5% +2.5%

= 7.5%

Project B:

Required Rate = Rf + Beta ( Rm - Rf )

= 5% + 1.5 (10% - 5%)

= 5% + 1.5 * 5%

= 5% +7.5%

= 12.5%

NPV of Project A:

Year	CF	PVF @7.5%	Disc CF
0	$ -1,000.00	1.0000	$ -1,000.00
1	$     500.00	0.9302	$     465.12
2	$     500.00	0.8653	$     432.67
3	$     500.00	0.8050	$     402.48
NPV			$     300.26

NPV of Project B:

Year	CF	PVF @12.5%	Disc CF
0	$ -1,000.00	1.0000	$ -1,000.00
1	$     500.00	0.8889	$     444.44
2	$     500.00	0.7901	$     395.06
3	$ 1,000.00	0.7023	$     702.33
NPV			$     541.84

Project B is selected .

Pls comment, if any further assistance is required.