Question
Spare Ltd manufactures car parts and management is considering an expansion of its existing operations at a cost of $600 000. It expects this expansion
Spare Ltd manufactures car parts and management is considering an expansion of its existing operations at a cost of $600 000. It expects this expansion to generate additional net cash inflows for the next 10 years as follows: $100 000 pa in Years 1-5 and $130 000 pa in Years 6-10. The company's analyst has made the following estimates:
a) the systematic risk of the company's existing assets is 0.75
b) the risk-free interest rate is 11% pa
c) the expected rate of return on the market portfolio is 15% pa
Assuming that there is no company income tax, should the company undertake the expansion?
The following answer is given by my lecturer, but I'm confused about the part that when calculate NPV, we need to *1.14^-5 at last? is it right?
ka= Rf + i(E(Rm) - Rf)
ka= .11 + .75(.15 - .11) =.14
NPV = -$600 000 + $100 000 PVIFA5,.14+ $130 000* PVIFA(5,.14)*1.14^-5
= -$24 897 Therefore reject expansion
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started