Question
ABC Inc. is considering acquiring two investment projects that are both expected to provide 10 years of cash flows. The expected year-end cash flows are
ABC Inc. is considering acquiring two investment projects that are both expected to provide 10 years of cash flows. The expected year-end cash flows are as follows: Project A: $200,000 (Years 1 10) Project B: $0 (Years 1 2) and $250,000 (Years 3 10) The required rate of return for both projects is 10% per year. (a) What is the present value of the cash inflows from (i) Project A; and (ii) Project B? (6 marks) (b) Suppose both projects cost $1,000,000 today. Using the net present value method to determine which project(s) should be taken if (i) both projects will be accepted if they are financially worthwhile; and (ii) only one project can be accepted even if both are worth to go ahead. (6 marks) (c) For Project B, put down the equation (NO calculation of the final answer is required) for its internal rate of return (IRR). (d) In general, how is IRR used in making investment decision? (e) According to the Capital Asset Pricing theory (CAPM), what return would be required by an investor whose portfolio is made up of 40% of the market portfolio (m) and 60% of Treasury bills (i.e. risk-free asset)? Assume the risk-free rate is 3% and the market risk premium is 7%?
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