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Mc Graw Hill The Treasury bill rate is 3% and the market risk premium is 8%
Mc Graw Hill
The Treasury bill rate is 3% and the market risk premium is 8%.
Internal Rate of
Project Beta Return, % P 0.85 14 Q 0.00 10 R 1.00 11 5 0.25 11 T 0.60 13
a. What are the project costs of capital for new ventures with betas of 0.60 and 115? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)
Beta Cost of Capital 0.6 % 1.15 %
b. Which of the capital investments shown above have positive (non-zero) NPV's? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)
Expert Solution
a) Computation of Expected Returns or Cost of Cost of Capital using CAPM:
Cost of Capital = Risk-free Rate + Beta* Market Risk Premium
Beta = 0.60,
Cost of Capital = 3% + 0.60*8% = 7.8%
Beta = 1.15,
Cost of Capital = 3% + 1.15*8% = 12.20%
b)
P: Cost of Capital = 3% + 0.85*8% = 9.80%
Q: Cost of Capital = 3% + 0*8% = 3%
R: Cost of Capital = 3% + 1*8% = 11%
S: Cost of Capital = 3% + 0.25*8% = 5%
T: Cost of Capital = 3% + 0.60*8% = 7.8%
For all projects except T, IRR is greater than the cost of capital. Thus, projects P,Q, R & S will have positive NPVs.
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