Question 1

You are a consultant to a large manufacturing corporation that is considering a project (beta of 1.8) with the following net after-tax cash flows:

Years from Now After-Tax Cash Flow

0 -40

1-10 15

Assume the risk-free rate is 8% and the market-rate is 16%. What is the NPV of then project? What is the highest possible beta before the NPV becomes negative?

Question 2

Suppose the rate of return on short-term government securities (considered risk-free) is 5%. The expected rate of return for a portfolio with a beta of 1.0 is 12%. According to the CAPM:

a. What is the expected rate of return on the market portfolio?

b. What would be the expected return on a stock with a beta = 0?

c. You are thinking of buying a stock at $40.00, and it is expected to pay a $3.00 dividend next year, and sell for $41.00. The stock risk is beta = -.5. Is the stock over- or under-priced?