Question

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

Years	Cash Flow ($ millions)
0	−180
1-12	46

The firm's existing assets have a beta of 2.2. The risk-free interest rate is 4% and the expected return on the market portfolio is 10%. What is the project's NPV? (Enter your answer in millions. A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

The question is solved by first computing the expected return of a stock.

The expected return on a stock is calculated using the Capital Asset Pricing Model (CAPM)

The formula is given below:

Ke= Rf+b[E(Rm)-Rf]

where:

Rf=risk-free rate of return

Rm=expected rate of return on the market.

Rm-Rf= Market risk premium

b= Stock’s beta

Ke= 4% + 2.2*(10% - 4%)

= 4% + 13.20%

= 17.20%.

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$180 million. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the expected return of 17.20%.
• Press the down arrow and CPT buttons to get the net present value.  

Present value of cash flows at 17.20% the expected return is $47.62 million.