A software company Future PLC can invest in either Project C or Project D which have the same initial Year = 0 cost of £275mlm and cash- flows: Project C: £150mln (in Year=1), £250mln (in Year=2) Project D: perpetuity of £25mln (in Year=1) growing at an annual rate of g=7% The problem is, that the firm does not know the risk-adjusted discount rate of Project C but it does know that the cash flow betas are 55 (in Year=1) and 85 (in Year=2). It also knows that Project D has the same risk as a market portfolio, which has an annual return of rm = 15%. Risk-free treasury bonds have an annual return of rf = 5%. Which project should be chosen by the firm?
A software company Future PLC can invest in either Project C or Project D which have the same initial Year = 0 cost of £275mlm and cash- flows: Project C: £150mln (in Year=1), £250mln (in Year=2) Project D: perpetuity of £25mln (in Year=1) growing at an annual rate of g=7% The problem is, that the firm does not know the risk-adjusted discount rate of Project C but it does know that the cash flow betas are 55 (in Year=1) and 85 (in Year=2). It also knows that Project D has the same risk as a market portfolio, which has an annual return of rm = 15%. Risk-free treasury bonds have an annual return of rf = 5%. Which project should be chosen by the firm?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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A software company Future PLC can invest in either Project C or
Project D which have the same initial Year = 0 cost of £275mlm and cash-
flows:
Project C: £150mln (in Year=1), £250mln (in Year=2)
Project D: perpetuity of £25mln (in Year=1) growing at an annual rate
of g=7%
The problem is, that the firm does not know the risk-adjusted discount rate
of Project C but it does know that the
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