Question

The Third Question: Answer the following Cases                                             

1- Calculate the required rate of return for Ali Inc., assuming that :

1. Investors expect a 8% rate of inflation in the future.
2. The real risk free rate is 6%.
3. The market risk premium is 10%.
4. The firm has a beta of 2
5. Its realized rate of return has averaged 30% over the last 10 years.

2) Nader Construction Co. is considering a new inventory system that will cost $1500,000. The system is expected to generate positive cash flows over the next four years in the amounts of $750,000 in year one, $650,000 in year two, $300,000 in year three, and $360,000 in year four. Nader's required rate of return is 16%. What is the net present value of this project?

3) What is the payback period for a project with an initial investment of $90,000 that provides an annual cash inflow of $20,000 for the first three years and $12500 per year for years four and five, and $25000 per year for years six through eight?

Answer 1

1) Required rate of return = Risk free rate + beta x Market risk premium

Required rate of return = 6% + (2 x 10%) =26%

2) NPV of the Project is $20629.71

Year	Cashflows	PV @ 16%
0	$       -15,00,000	-1500000.00
1	$           7,50,000	646551.72
2	$           6,50,000	483055.89
3	$           3,00,000	192197.30
4	$           3,60,000	198824.80
NPV	20629.71

3)  Payback Period is

Year	Cashflows	Cummulative Cashflows
0	$                                             -90,000
1	$                                               20,000	$                                               20,000
2	$                                               20,000	$                                               40,000
3	$                                               20,000	$                                               60,000
4	$                                               12,500	$                                               72,500
5	$                                               12,500	$                                               85,000
6	$                                               25,000	$                                           1,10,000
7	$                                               25,000	$                                           1,35,000
8	$                                               25,000	$                                           1,60,000

Payback Period = 5 + (90000 - 85000 ) /25000

Payback Period = 5.20 years

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