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Capital Budgeting

A steel comapny is the using the capital asset pricing model to evaluate a possible investment project.

The proposed project involves an investment of 15.2 million to start uo a toy manufacturing plant. the proposed project has about the same risk as the maerket(beta=1) and a project return of 30 percent. Additionally, the project has virtue of helping the company diversify away from total reliance on the steel business. The government bond rate is 12 percent and the market risk premium is 10 percent. For the steel campany as presently constituted, the beta is 2.2 Should the steel company undertake the proposed investment? explain your answer ( step of calcualtion must be shown)

Solution Preview

In order to decide whether the proposed investment should be undertaken, we need to compare the returns generated by the project with the cost of capital.

In calculating the cost of capital, using the CAPM equation, there is a need to use the value for beta. The beta for the project is given as 1 and the beta for the company is given as 2.2. The question is which beta to use. In evaluating projects, the risks of the project should be adjusted in the ...

Solution Summary

The solution explains how to make a decision whether to accept or reject a project.