You are a consultant to a large manufacturing corporation co

You are a consultant to a large manufacturing corporation considering a project with the following net after-tax cash flows (in millions of dollars):

The project\'s beta is 1.5. Assuming rf = 6% 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 _____ million

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 _____

Solution

Expected return = Risk free return + beta * Market risk premium

= 6 + 1.5 * (12-6)

= 15 %

To calculate the highest possible ? estimate for a positive NPV, calculate the projects IRR

Use the calculator’s CF register or use Excel:

CF0= -26, CF1-9= 16, N1= 10, IRR = 61.34 %

So the highest ? before the hurdle rate exceeds the IRR is:

E(r) = rf+ ? * [E(rM ) – rf ]

? = [E(r) – rf] / [E(rM ) – rf ]

? = [0.6134 - 0.06]/[0.12 – 0.06]

= 9.22