Question

a). What is the market risk premium if the risk free rate is 5% and the expected market return is given as follows?

State of nature	Probability	Return
Boom	20%	30%
Average	70%	15%
Recession	10%	5%

b). A firm is evaluating two projects that are mutually exclusive with initial investments and cash flows as follows:

Project A

Project B

Initial Investment	End-of-Year Cash Flows	Initial Investment	End-of-Year Cash Flows
RM40,000	RM 20,000	RM 90,000	RM 40,000
	RM 20,000		RM 40,000
	RM 20,000		RM 80,000

i). Which project should the firm choose if it has a required payback period of two years? Explain your answer.

ii). If the firm's required rate of return is 15%, which project should be chosen? Why?

Answer 1