Part 1 Investment with a beta b. of 1.70 The risk-free rate of return, RF, is 8%
ID: 2657408 • Letter: P
Question
Part 1 Investment with a beta b. of 1.70 The risk-free rate of return, RF, is 8%. The return on the market portfolio of assets, rm, is 12% This investment will earn an annual rate of return of 13%. Requirement what would you expect to happen to the investment's return? a. If the return on the market portfolio were to increase by 9%, b, if the market return were to decline by 9%? b. use capital asset pricing model (CAPM) is used to find c. the basis of your calculation in part b, would you d. Assume that as a result of investors becoming less risk the required return on this investment, discuss the result? recommend this investment? Why or why not? averse, the market return drops by 2% to 7%. What impact would this change have on your responses in parts b and c?Explanation / Answer
Part 2 Book Value weights Market Value Long Term debt 8000000 0.784314 7680000 0.556522 Preferred stock 80000 0.007843 120000 0.008696 common stock 2120000 0.207843 6000000 0.434783 Total 10200000 13800000 a 0.06*0.784314+ 0.13*0.007843 + 0.17*0.207843 0.08341174 WACC 8.34% Based on Book Value, WACC is 8.34% (0.06*0.556522) + (0.13*0.008696) + (0.17*0.434783) 0.10843491 WACC 10.84% Based on market value, WACC is 10.84% b Book value approach is preferred approach due to lower cost of capital for the company Part 3 Project M Project N Initial Investment 28500 27000 Year Cash flows Cumulative 1 10000 11000 11000 2 10000 10000 21000 3 10000 9000 30000 4 10000 8000 38000 Payback period Project M 28500/10000 2.85 Project N 2 yrs + 3000/30000 2.1 Project N is preferable because it has lower payback period Net Present Value Year Discount factor @ 14% Project M cash flow Present Value Project N cash flow Present Value 0 1 -28500 -28500 -27000 -27000 1 0.877192982 10000 8771.93 11000 9649.123 2 0.769467528 10000 7694.675 10000 7694.675 3 0.674971516 10000 6749.715 9000 6074.744 4 0.592080277 10000 5920.803 8000 4736.642 Net Present Value 637.123 1155.184 Based on NPV, Project N is preferable because it has higher NPV IRR Project M Using IRR function in excel we get IRR(J45:J49,16%) 15.08632803% IRR for Project M is 15.09% Project N Using IRR function in excel we get IRR(L45:L49,16%) 16.19349% IRR for Project N is 16.19% Based on IRR, Project N is preferable since it has higher IRR