On the basis of the data provided at question 3, what is your expected NPV if you invest $ 150 mi in this hotel today? Consider your WACC to be 10%. O a. -$1,002,273 O b. $1,002,273 O c. $4,961,520 O d. -$911,158
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Please only answer practice question 5
Solution for question 3 & 4 below:
Question 3. Option A
|
Year |
Formula |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
|
Growth rate (Revenue) |
|
|
1.02 |
1.03 |
1.04 |
1.03 |
1.025 |
1.025 |
|
Revenue |
Previous year rev* growth rate |
55.00 |
56.10 |
57.78 |
60.09 |
61.90 |
63.44 |
65.03 |
|
Growth rate (Expenses) |
|
|
1.04 |
1.07 |
1.04 |
1.03 |
1.025 |
1.025 |
|
Expenses |
Previous year exp*Growth rate |
(40.00) |
(41.60) |
(44.512) |
(46.29248) |
(47.681254) |
(48.87329) |
(50.09512) |
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|
Net Income |
Revenue-Expenses |
15.00 |
14.50 |
13.27 |
13.80 |
14.22 |
14.57 |
14.94 |
|
Cost of sales(% of revenue) |
Revenue*3% |
(1.65) |
(1.683) |
(1.73349) |
(1.80283) |
(1.856914) |
(1.90334) |
(1.95092) |
|
Net income (after selling cost) |
Net income - Cost of sales |
13.35 |
12.82 |
11.54 |
12.00 |
12.36 |
12.67 |
12.98 |
|
Discount rate |
1.09n where n is the year |
1.0900 |
1.1881 |
1.295029 |
1.4115816 |
1.538624 |
1.6771 |
1.828039 |
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|
Net income/Discount rate |
12.247706 |
10.787812 |
8.909075 |
8.500401 |
8.032489 |
NA |
NA |
|
Total present value of first 5 years |
|
48.477484 |
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Total present value of first 5 years = 48.477484. Option A
Find the expected
Question 4. Option C
IRR for an investment of $150MM = -23.89%
Options B and D are higher than 9% so focus is placed on options A and C.
|
Year |
Formula |
1 |
2 |
3 |
4 |
5 |
|
At -16.96% discount rates are (option A) |
(1-0.1696)n |
0.8304 |
0.6896 |
0.5726 |
0.4755 |
0.3949 |
|
Present value |
Net income/Discount rate |
16.08 |
18.59 |
20.15 |
25.23 |
31.30 |
|
Total present values of the 5 years |
|
11.35 |
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At -23.89% discount rates are (Option C) |
=(1-0.2389)n |
0.7611 |
0.5793 |
0.4409 |
0.3356 |
0.2554 |
|
Present value |
Net income/Discount rate |
17.54 |
22.13 |
26.17 |
35.76 |
48.39 |
|
Total present values of the 5 years |
|
149.99 |
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Therefore, the IRR for an investment of $150MM is -23.98%. Answer is option C
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