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6. Epsilon Corp. is evaluating an expansion of its business. The cash-flow forecasts for the project...

6. Epsilon Corp. is evaluating an expansion of its business. The cash-flow forecasts for the project are as follows:

Years Cash Flow ($ millions)

0 −40

1-5 +20

The firm currently has a beta of 1.2. The 10-year US Treasury Note currently pays 2.5 percent annually and the market risk premium has averaged 6.5 percent in the United States. Use the Capital Asset Pricing model to estimate the firm’s opportunity cost of capital and find the NPV of the above expansion project. Should the firm proceed with the expansion?

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Answer #1

4 Beta Risk free rate Market risk premium Cost of capital 1.2 2.50% 6.50% 10.300% Cash flow Year 12 20 20 20 20 20 2 16 17 18

Beta Risk free rate Market risk premium Cost of capital 1.2 0.025 0.065 :06+07* D5 Cash flow Year 12 13 20 20 20 20 20 2 17 1

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