Question

If Microsoft decides to invest 3 million dollars, and believes it will have sales of 100k in the first year and after that sales will increase by 25% per year for the next 3 years. Also, after those 3 years sales will then grow at a constant 3% rate forever. Market risk premium of 4.4%. Beta .52. Yearly T Bill rate of 2.6% Should I make this investment? Why or why not? Please show NPV and Cash flow formulas.

Answer 1

Required Return = Risk-free Rate + [Beta * Market Risk Premium]

= 2.6% + [0.52 * 4.4%] = 2.6% + 2.288% = 4.888%

PV of revenues = [Sales1 / (1 + r)] + [{Sales1 * (1 + g1)} / (1 + r)²] + [{Sales1 * (1 + g1)²} / (1 + r)³] + [{Sales1 * (1 + g1)³} / (1 + r)⁴] + [{Sales1 * (1 + g1)³ * (1 + gC)} / {(r - gC) * (1 + r)⁴}]

= [$100,000 / (1 + 0.04888)] + [{$100,000 * (1 + 0.25)} / (1 + 0.04888)²] + [{$100,000 * (1 + 0.25)²} / (1 + 0.04888)³] + [{$100,000 * (1 + 0.25)³} / (1 + 0.04888)⁴] + [{$100,000 * (1 + 0.25)³ * (1 + 0.03)} / {(0.0488 - 0.03) * (1 + 0.04888)⁴}]

= $95,339.79 + $113,620.95 + $135,407.47 + $161,371.49 + $8,803,635.57

= $9,309.375.27

NPV = PV of Revenues - Cost of Investment

= $9,309,375.27 - $3,000,000 = $6,309,375.27

So, we should make this investment as the npv is positive.