As an analyst at Monsters Inc you spend time reviewing the crazy investment opportunities your boss discovers. Today, your boss decided that in an effort to help you avoid worrying about anything except the financial decisions, you will not be told what line of business the deal in question involves. As such, you are being asked to make a financial decision based on the merits of the numbers without regard to exactly what type of business venture your crazy boss is contemplating. (This simplifies your thinking!)

Key Operating Metrics for the Market and Monsters INC. used in your Analysis:

The mean historic return in the market for risky assets used for firm estimation of deal prospects is 8% annualized. R_m = .08

Risk-free rate (for all terms) = 1.50%

Corporate Financial Conditions for Capital Analysis:

LT Debt Par Value $1.0 Billion, Maturity T = 15 yrs, m =2, Coupon Rate = 6.0%, Current Price = 103.58

Equity: Outstanding Shares = 100 million shares, Current Stock Price = $30

Firm Beta (vs. Mkt portfolio) = 1.5

Effective Tax Rate = 30%

Use the information about Monsters Inc. to answer the questions about Project 1

Project 1 (continued):

Investment (Deal) Performance Specifics:

Capital Allocation per deal unit = $1.0M

# Deal units involved = 4

Probability of Success per unit = 55.0%; Failure per unit = 45.0%

Risk-Premium for Project 1 = 10.0%

Cash Flow Estimations:

Assume it takes two years to begin operations from the time capital is deployed. If the plan succeeds Operating Cash Flows = CF(3) =$300,000, CF(4) = 400,000, and will grow continuously at 4.0% thereafter.

If the project fails, liquidate the position for a pre-tax salvage value of $714,285 at the end of year two and cut losses. (Remember to convert Salvage to OCF by multiplying by (1-T).

Calculate the probability and NPV for every possible outcome and use to estimate expected NPV of the project.

Questions: (show all your work):

What is the Weighted Average Cost of Capital for the Monsters INC Project 1?

What is the probability of occurrence for each outcome (0,1,2,3,4 Successes)

What is the Net Present Value of Project 1?

Would you approve or reject the proposal? Why?