The Beta for a producing well is 0.7. The market risk premium is 7.5%, and the risk-free-rate is 3.6%. For simplicity assume there are no taxes and make further assumptions as necessary. a. What is the correct discount rate for cash flows from the developed wells? b. What is the NPV of the cash flows from the well if you are guaranteed to strike oil (i.e., ignoring the risk of a dry hole)? Construct a pro forma to show your answer. c. The oil company executive proposes to add 20 percentage points to the discount rate to offset the risk of a dry hole. He calls this a "fudge factor." Calculate the NPV of the well with this adjusted discount rate. d. What do you say the NPV of the well is? Is it your answer from b or your answer from c, or something else? Why? If it is something else, please calculate it here.

The Beta for a producing well is 0.7. The market risk premium is 7.5%, and the risk-free-rate is 3.6%. For simplicity assume there are no taxes and make further assumptions as necessary. a. What is the correct discount rate for cash flows from the developed wells? b. What is the NPV of the cash flows from the well if you are guaranteed to strike oil (i.e., ignoring the risk of a dry hole)? Construct a pro forma to show your answer. c. The oil company executive proposes to add 20 percentage points to the discount rate to offset the risk of a dry hole. He calls this a "fudge factor." Calculate the NPV of the well with this adjusted discount rate. d. What do you say the NPV of the well is? Is it your answer from b or your answer from c, or something else? Why? If it is something else, please calculate it here.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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The Profitability Index (PI) is a financial metric that depends only on the Present Value (PV) of expected future cash inflows. This statement is: a False. b Only partly true. c True d Only partly false.
A graph of the discounting process shows how the present value of any sum to be received in the future decreases and approaches _______ as the years to receipt increases, and the present value declines faster at ______ interest rates. The fundamental goal of financial management is to maximize the firm’s value, and the value of any asset is the ______ value of its expected future cash flows.
Manipulating CAPM Use the basic equation for the capital asset priding model (CAPM) to work each of the following problems. a. Find the required return for an asset with a beta of 1.63 when the risk-tree rate and market return are 5% and 13%, respectively b. Find the risk-free rate for a firm with a required return of 14.363% and a beta of 1.07 when the market return is 14%. C. Find the market return for an asset with a required return of 9.045% and a beta of 1.57 when the risk-free rate is 3%. d. Find the beta for an asset with a required return of 10.255% when the risk-free rate and market retum are 6% and 9.7%, respectively a. The required return for an asset with a beta of 1.63 when the risk-free rate and market return are 5% and 13%, respectively, is % (Round to two decimal places.)
The expected return for the investment is ??? The standard deviation is ??? While the expected return for the risk-free assets, Treasury Bills, is ??? The standard deviation is ???
Puji International Freight Company (PIFC) wishes to determine the required return on Asset J, which has a beta of 1.75. The risk-free rate of return is 6.4% and the return on the market portfolio of assets is 10.8%. Suppose PIFC is also considering investing in asset K, which has a beta of 1.8. Is there a market premium or market discount? Justify your answer. Determine the required return of assets J and K. Show your solutions. Interpret your answer. Graph the Security Market Line for both assets. Between assets J and K, can you determine which has more total risk and which has more market risk? Determine which stock has a higher cost of equity capital. If you are the financial consultant of PIFC, what will be your investment strategy?
What is the 'golden rule' for finding the Internal Rate of Return (IRR) of an investment project cash flow? a)Vary the discount rate until the net present value of the cash flow equals zero. b)Vary the discount rate until the net present value of the cash flow is positive c)Vary the discount rate to the point of maximum increase in the net present value d)Vary the discount rate until the net present value of the cash is negative
The risky portfolio expected return and standard deviation is 14% and 20%, respectively. The risk free rate is 5%. The risk aversion coefficient A is 2.5 and 4 for Mary and Kim, respectively. Answer the following questions: A. Who is more risk averse? B. What is the capital allocation y to the risky portfolio for each investor? C. Suppose investors have the following utility function: U = E(R) - ¹2 Ao² Calculate the Utility level for each investor's optimal complete portfolio.
The expected market return is 5%. The risk-free rate is 3%. According to the CAPM equation, what is the expected return on an asset which has alpha=1.5%, and beta=1.9 ? O a. 11.0% O b. 5.3% O c. 5% O d. 6.8% O e. 8.3%
What is the expected market return if the expected return on asset A is 19% and the risk free rate is 5%? Asset A has a beta of 1.4. Assume that the CAPM is correct. a. 5% b. 9% c. 13% d. 15% e. 19%
D4) Finance The cash position of a merchant is 10000 bushels of wheat , the variance of the changes of forward price is 0.00094, the variance of the changes of the base is 0.000453, the variance of the cash price changes is 0.000805 and the covariance of the changes of forward price with the changes of the cash prices is 0.000518. Calculate the efficiency of the hedge and choose one of the following answers. a. 0.97 b. 0.31 c. 0.69 d. 0.03
Risk-adjusted rates of return using CAPM Centennial Catering, Inc., is considering two mutually exclusive investments. The company wishes to use a CAPM-type risk-adjusted discount rate (RADR) in its analysis. Centennial's managers believe that the appropriate market rate of return is 12.2%, and they observe that the current risk-free rate of return is 7.4%. Cash flows associated with the two projects are shown in the following table. (Click on the icon here in order to copy the contents of the data table below into a spreadsheet) Initial investment (CFO) Year (f) 1 234 Project X $67,000 Project Y $84,000 Cash inflows (CF) $30,000 30,000 30,000 30,000 $26,000 32,000 42,000 48,000 a. Use a risk-adjusted discount rate approach to calculate the net present value of each project, given that project X has an RADR factor of 1.19 and project Y has an RADR factor of 1.39. The RADR factors are similar to project betas. (Hint: Use the following equation to calculate the required project return…

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