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.

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A: Formulas:

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A:

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Production Budget

A budget can be defined as a financial plan designed by an undertaking for a definite period in the future that can contribute towards enhancing the financial success of the business undertaking. It is used to estimate the revenue and expenses. The budget generally takes into account both current and future income and expenses.