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CAPM, risk-adjusted net present value, simulation

Problem 1
Use CAPM methodology to compute the following:

A. Compute a fair rate of return for Intel common stock with a beta of 1.2. The risk free rate is 6% and the NYSE market portfolio has an expected return of 16%.

B. Why is the rate you computed a fair rate?

Problem 2
The Niagra corporation is considering two mutually exclusive projects. Both require an initial outlay of $10,000 and will operate for 5 years. Project A will produce expected cash flows of $5,000 per year for years 1 through 5 and project B will produce expected cash flows of $6,000 per year for years 1 through 5. Management of Niagra believes that project B is the riskier project and therefore assigns a required rate of return of 15% to its evaluation and only a 12% required rate of return to project A. Calculate each projects risk-adjusted net present value. (be sure to show your work)

Problem 3

Explain how simulation works. What is the value in using a simulation approach?

Solution Preview

The answers are also in the attached file:
Problem 1
Use CAPM methodology to compute the following:

A. Compute a fair rate of return for Intel common stock with a beta of 1.2. The risk free rate is 6% and the NYSE market portfolio has an expected return of 16%.

CAPM (Capital Asset Pricing Model) equation is:
r A= r f + beta A (r m - r f)

risk free rate= r f = 6%
beta of stock= beta A= 1.2
return on market portfolio= r m = 16% (NYSE market portfolio)
required return on stock r A = to be determined
Plugging in the values
r A = 18. % =6.%+1.2*(16.%-6.%)

Answer: fair rate of return= 18. %

B. Why is the rate you computed a fair rate?

The rate that has been computed is a fair rate of return because it takes into account the systematic risk (as measured by beta) of intel stock.

Problem 2
The Niagra corporation is considering two mutually exclusive projects. Both require an initial outlay of $10,000 and will operate for 5 years. Project A will produce expected cash flows of $5,000 per year for years 1 through 5 and project B will produce expected cash flows of $6,000 per year for years 1 through 5. Management of Niagra believes that project B is the ...

Solution Summary

Three questions on CAPM, risk-adjusted net present value, simulation have been answered.

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