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? (LO12-3) 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?

only answer question 32. 31 is considered help for problem 32 thats why it is included.

Answer 1

1.

Using financial calculator

N=10

PV=-100

PMT=15

FV=0

CPT I/Y=8.14%

Hence, IRR is 8.14%

2.

Required return=risk free rate+beta*(market return-risk free rate)=4%+1.4*(12%-4%)=15.20%

3.

Reject as IRR is less than required return

Yes IRR rule agrees with NPV rule