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- April 21, 2015 at 9:44 pm #242126
I am studying corporate finance. i need help for following question below.
1. a) The management of firm A is considering starting a new project. The project requires an initial investment equal to £1,000,000. The risk of the project is identical to that of the firm’s current risky assets. The expected rate of return on the new project is 15% annually in perpetuity. The firm’s balance sheet (market values) prior to the announcement of the investment project is as follows:
Fixed assets £ 5,000,000 Equity £4,000,000
Cash £1,000,000 Debt £2,000,000
Total 6,000,000 Total 6,000,000
There are 100,000 shares outstanding. The beta of the firm’s stock is equal to 1.35; the beta of its debt is equal to 0.15. The risk-free rate is equal to 4%, and the expected market risk premium is 7%.
i) Calculate the beta and the expected return of the firm using the Capital Asset Pricing Model (CAPM).
ii) How reliable are the CAPM and the C-CAPM in enabling a firm to measure the cost of capital?
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