Question

Need help with 19 & 20

[Q19-20] You are the CFO of a major pharmaceutical firm. A division manager has presented senior management with an investment opportunity. • The project would require an investment of $95 million today • If the project succeeds, it will be worth $1 billion in a year. You estimate that there is only a 10% chance that the venture would succeed. If it fails, then in a year you will scrap the project and all of your firm's $95 million investment will be lost. • Whether the venture succeeds or fails is independent of general market conditions. • The risk-free rate is 3%, the expected return of the market is 12%, and the standard deviation of the market return is 20%. What is the beta of the project? What is the appropriate discount rate for the project under the assumptions of CAPM? [Hint: “Whether the venture succeeds or fails is independent of general market conditions."] A. O, 3% B.1, 12% C. 1.5, 16.5% D.0.5, 7.5% QUESTION 20 3 points Save Answer What is the NPV of this project? A. -$1.3M

Answer 1

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Answer:

Since it is mentioned the project is independent of the outcome of general market

=> beta = 0

$\large r = r_f + \beta *(r_m-r_f)$

=> r = 3% + 0*(12%-3%) = 3%

$\textup{Expected value of Project in one year} = \textup{\$1 billions * .1 + \$*0.9}$

$\textup{Expected value of Project in one year} = \textup{\$100 millions}$

$NPV = \frac{\textup{Expected value of Project in one year}}{(1+0.03)}-\textup{Initial cost}$

$NPV = \frac{\textup{100}}{(1+0.03)}-\textup{95}$

$NPV =97.1-95$

$\bg_green \large NPV = \textup{2.1 million}$