Exercise 3 Suppose you have two mutually exclusive projects that you can carry out either on Younge Street or King West: build an ax throwing facility or a floating spa. Assume that the ax throwing facility has the following cash flows: an immediate cash outlay of $50,000 followed by inflows of $25,000 in each of the next three years, and zero thereafter. The floating spa has the following cash flow: an immediate outlay of $50,000 followed by inflows of nothing in year one, $10,000 in year 2, $70,000 in year 3, and zero thereafter. a. Both projects are star-ups, so you do not have any information on their cost of capital. You think that 'Six Flags" (SIX) stock prices constitute a good proxy for the riskiness of the ax throwing facility project. Use CAPM and the information on Six Flags returns over the past 5 years, to estimate the cost of capital for the ax throwing facility. b. Given the cost of capital estimated in a), what is the Net Present Value (NPV) of the the ax throwing project? c. Find an exchange listed company that you think constitute a good proxy for the riskiness of the floating spa project. Justify your choice. d. What is the cost of capital for the floating spa project? Use the last 5 years to estimate the cost of capital. e. What it the NPV of the floating spa project? Which project would you choose given you NPV calculations. f. People often calculate the Internal Rate of Return (IRR), defined as the cost of capital (i.e., required rate of return) at which the project's NPV=0. This can lead to incorrect 2 investment decisions, if the IRR is used as an investment criterion, ignoring the actual cost of capital. If you base your investment decision on whichever project has the highest IRR, which do you choose? Exercise 3 Suppose you have two mutually exclusive projects that you can carry out either on Younge Street or King West: build an ax throwing facility or a floating spa. Assume that the ax throwing facility has the following cash flows: an immediate cash outlay of $50,000 followed by inflows of $25,000 in each of the next three years, and zero thereafter. The floating spa has the following cash flow: an immediate outlay of $50,000 followed by inflows of nothing in year one, $10,000 in year 2, $70,000 in year 3, and zero thereafter. a. Both projects are star-ups, so you do not have any information on their cost of capital. You think that 'Six Flags" (SIX) stock prices constitute a good proxy for the riskiness of the ax throwing facility project. Use CAPM and the information on Six Flags returns over the past 5 years, to estimate the cost of capital for the ax throwing facility. b. Given the cost of capital estimated in a), what is the Net Present Value (NPV) of the the ax throwing project? c. Find an exchange listed company that you think constitute a good proxy for the riskiness of the floating spa project. Justify your choice. d. What is the cost of capital for the floating spa project? Use the last 5 years to estimate the cost of capital. e. What it the NPV of the floating spa project? Which project would you choose given you NPV calculations. f. People often calculate the Internal Rate of Return (IRR), defined as the cost of capital (i.e., required rate of return) at which the project's NPV=0. This can lead to incorrect 2 investment decisions, if the IRR is used as an investment criterion, ignoring the actual cost of capital. If you base your investment decision on whichever project has the highest IRR, which do you choose
