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The Treasury bill rate is 5% and the market risk premium is 8%. Project Beta Internal...

The Treasury bill rate is 5% and the market risk premium is 8%.
Project Beta Internal Rate of Return, %
       P 1.00       16            
       Q 0       8            
       R 2.00     22            
       S 0.40       9            
       T 1.90       20            
a.

What are the project costs of capital for new ventures with betas of .75 and 1.55? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Beta       Cost of Capital
0.75           %   
  1.55           %   
b.

Which of the following capital investments have positive NPVs? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)
  • P
  • Q
  • T
  • R
  • S

Solutions

Expert Solution

Answer a.

If beta is 0.75:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 5.00% + 0.75 * 8.00%
Cost of Capital = 11.00%

If beta is 1.55:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 5.00% + 1.55 * 8.00%
Cost of Capital = 17.40%

Answer b.

Project P:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 5.00% + 1.00 * 8.00%
Cost of Capital = 13.00%

IRR is higher than cost of capital, therefore, the NPV is positive.

Project Q:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 5.00% + 0.00 * 8.00%
Cost of Capital = 5.00%

IRR is higher than cost of capital, therefore, the NPV is positive.

Project R:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 5.00% + 2.00 * 8.00%
Cost of Capital = 21.00%

IRR is higher than cost of capital, therefore, the NPV is positive.

Project S:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 5.00% + 0.40 * 8.00%
Cost of Capital = 8.20%

IRR is higher than cost of capital, therefore, the NPV is positive.

Project T:

Cost of Capital = Risk-free Rate + Beta * Market Risk Premium
Cost of Capital = 5.00% + 1.90 * 8.00%
Cost of Capital = 20.20%

IRR is lower than cost of capital, therefore, the NPV is negative.

jeff jeffy answered 4 months ago
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