A project generates 10 years of cash flows. The cash flow for the first year is 100,000. For the remaining years cash flows are projected to grow at a rate of 3%. The required initial investment is $250,000. Assume that the company is 100% equity finance (there is no debt in the capital structure of this company). The risk-free rate of interest of 3% and the expected market risk premium is 7%. If we assume that the beta of the firm is 0.9 when in fact the beta is really 1.5, for how much more or less (in dollars) are we valuing the investment project? Explain in words why the estimation of the value of project assuming a beta of 0.9 is incorrect.

A project generates 10 years of cash flows. The cash flow for the first year is 100,000. For the remaining years cash flows are projected to grow at a rate of 3%. The required initial investment is $250,000. Assume that the company is 100% equity finance (there is no debt in the capital structure of this company). The risk-free rate of interest of 3% and the expected market risk premium is 7%. If we assume that the beta of the firm is 0.9 when in fact the beta is really 1.5, for how much more or less (in dollars) are we valuing the investment project? Explain in words why the estimation of the value of project assuming a beta of 0.9 is incorrect.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter11: Capital Budgeting And Risk

Section: Chapter Questions

Problem 6P

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