First and Ten Corporation’s stock returns have a covariance with the market portfolio of .0506. The standard deviation of the returns on the market portfolio is 23 percent and the expected market risk premium is 6.5 percent. The company has bonds outstanding with a total market value of $56.8 million and a yield to maturity of 6.8 percent. The company also has 6 million shares of common stock outstanding, each selling for $33. The company’s CEO considers the firm’s current debt-equity ratio optimal. The corporate tax rate is 23 percent and Treasury bills currently yield 4.4 percent. The company is considering the purchase of additional equipment that would cost $58 million. The expected unlevered cash flows from the equipment are $19.1 million per year for 5 years. Purchasing the equipment will not change the risk level of the firm. Calculate the NPV of the project. Very much struggling with setting this up and solving this problem.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
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First and Ten Corporation’s stock returns have a covariance with the market portfolio of .0506. The standard deviation of the returns on the market portfolio is 23 percent and the expected market risk premium is 6.5 percent. The company has bonds outstanding with a total market value of $56.8 million and a yield to maturity of 6.8 percent. The company also has 6 million shares of common stock outstanding, each selling for $33. The company’s CEO considers the firm’s current debt-equity ratio optimal. The corporate tax rate is 23 percent and Treasury bills currently yield 4.4 percent. The company is considering the purchase of additional equipment that would cost $58 million. The expected unlevered cash flows from the equipment are $19.1 million per year for 5 years. Purchasing the equipment will not change the risk level of the firm. |
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