Chapter 10, Problem 15PROB

Summary Introduction

CAPM: Capital asset pricing model. This is the method used to find required rate of return, for given level of risk.

Calculate the cost of capital as follows:

$\text{Cost of capital}=\text{Riskfree rate}+\left(\text{Beta}\times \left(\text{Market rate}-\text{Riskfree rate}\right)\right)$

Net present value:

Net present value is the difference between the present values of cash inflows minus present value of cash outflows.

Calculate the net present value as follows:

$\text{Net present value}=\text{Present value of cash inflows}-\text{Initial investment}$

Decision rule:

$\begin{array}{l}\text{NPV}>\text{0 Accept the project}\\ \text{NPV}<\text{0 Reject the project}\end{array}$

QQ is adding another division that requires initial outlay of $29,500 and generate cash inflows of $6,250. The given the market rate is 11%, risk free rate is 4% and beta is 0.8.