Gerhart Ltd. is an unlevered company with an issued capital of 10 million shares. Currently, the company has no assets except for an investment in highly-liquid Treasury bills valued at $100 million. The yield on the bills is 10 percent per annum.

Gerhart can invest $50 million of its near-cash asset today in one of two available projects, Alpha or Beta. Project Alpha is expected to generate a perpetual stream of free cash flows, starting with $13.5 million one year from now, thereafter growing at an expected rate of 3 percent per annum. Project Beta, also perpetual, is expected to produce a free cash flow of $10 million in one year’s time, growing at an expected rate of 5 percent per annum thereafter.

When answering this question, show all formulae, working and calculations.

Required:

a) Compute the Net Present Value and Internal Rate of Return for each project. Comment if the two approaches agree on project choice, and if they disagree, explain the reason for the conflict.

b) Which project should Gerhart choose? Provide a reasoned recommendation.

c) What will be Gerhart’s new share price if the company announces it will adopt Project Alpha? What will be the new share price if it adopts Project Beta? Assume the projects are private information to Gerhart’s

managers.

d) Suppose Gerhart announces it will undertake project Alpha, and its share price dropped. Explain whether this is consistent or not with the semi-strong form and strong form of the Efficient Market Hypothesis.