Returns on the market and Company Y's stock during the last 3 years are shown below:
Year Market Company Y -
1995 -24% -22%
1996 10 13
1997 22 36
The risk-free rate is 5 percent, and the required return on the market is 11 percent. You are considering a low-risk project whose market beta is 0.5 less than the company's overall corporate beta. You finance only with equity, all of which comes from retained earnings. The project has a cost of $500 million, and it is expected to provide cash flows of $100 million per year at the end of Years 1 through 5 and then $50 million per year at the end of Years 6 through 10. What is the project's NPV (in millions of dollars)?
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A. B. C. D. E.E
Step 1 Run a regression to find the corporate beta. Market returns are the X-input values, while Y's returns are the Y-input values. Beta is 1.2102.
Step 2 Find the project's estimated beta by subtracting 0.5 from the corporate beta. The project beta is thus 1.2102 - 0.5 = 0.7102.
Step 3 Find the company's cost of equity, which is its WACC because it uses no debt: k(s) = WACC = 5% + (11% - 5%)0.7102 = 9.26%.
Step 4 Now find the project's NPV (inputs are in millions):
CF(0) = -500 -
CF(1-5) = 100 -
CF(6-10) = 50 -
I = 9.26%
Solve for NPV = $10.42 million.