2. Suppose the annual return in the stock market is 8%. Suppose company Z has no...

2. Suppose the annual return in the stock market is 8%. Suppose company Z has no debt, the risk-free rate is 2% and the beta for Z is 1.15. Managers have proposed a new project whose projected cash are $5 million each year for the next five years. There is no projected residual value. What is the most the firm should invest in this project?

Expert Solution

We have to compute the required rate first using CAPM

required rate = Risk free rate+ (market rate- risk free rate)*Beta

		2%+(8%-2%)*1.15
		8.90%


the most the firm should invest in this project is the present value of future cash flow

computation of present value
	i	ii	iii=i*ii
year	Cash flow	PVIF @ 8.9%	present value
0	0	1.0000	-
1	5000000	0.9183	4,591,368
2	5000000	0.8432	4,216,132
3	5000000	0.7743	3,871,563
4	5000000	0.7110	3,555,155
5	5000000	0.6529	3,264,605
			19,498,823

Therefore maximum investment value =	19,498,823

jeff jeffy answered 2 years ago

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