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Hello tutor, hope and pray you’re doing well,
Its’ june 2010, paper, Q4, QSX…
There’s a certain paragraph in the solution, I am finding hard to understand..
When solved for the year 08, the return on equity predicted by CAPM is less than the actual total shareholder return whereas in 09, the predicted return is more than the actual return..The paragraph goes like this,
”Because the risk-free rate of return of return is positive and equity risk premium is either zero or positve, and because negative equity betas are very rare, the return on equity predicted by the CAPM is invariably positive. This reflects the reality that shareholders will always want a return to compensate for taking on risk.”
Thank you in advance.
What they are saying is this.
Because there is always risk in investing in shares, it would seem sensible that shareholders will want a higher return from share then they get from an investments with zero risk (for example, government stocks – these days, even investing in government might be risky, but in theory it is the safest investment you could make – fixed interest and no risk of not being repaid).
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Hello I´m having difficulty in example given below. I cant understand which way to go for it.
The company Green Oil Inc is developing a new oil field, and have so far invested 230 million Rs in exploration. The report indicates an oil field with a possible production of 600 mboe (million barrel of oil equivalents) at a 62% recovery rate. 2 years of development will cost 5.0 billion Rs, and will be followed by a production at 120 mboe each year for 5 years. The average price of oil during these years is estimated to be $100 (= 550 Rs) per barrel. During production, the fixed costs equal 2.0 billion Rs, and variable costs equal 200 Rs per barrel. The company pays 78% taxes from oil production in the North Sea.
Below are the variables reviewed:
Variable Value Unit
Sales price 550 Rs/barrel
Variable cost 200 Rs/barrel
Fixed costs 2 000 000 000 Rs/year
Annual production 120 000 000 Barrels
Development cost(year 1 and 2) 5 000 000 000 Rs
Project life 5 Years
Salvage value 0 Rs
Discount rate 10 %
Tax rate 78 %a) Set up the project’s cash flow and calculate the Net Present Value (NPV) by assuming a discount rate at 10%. Should Green Oil Inc make the investment?
Green Oil Inc is considering using a new environmental friendly technology for this oil field. The technology will increase the recovery rate of oil from 62% to 70%, and therefore increase the possible reserves for production. However, on a large scale production site, the technology is not 100% reliable, and Green Oil would need to invest in a research project to be certain about the prospects of the technology. The research project is estimated at 500 million Rs per year and will take 2 years before any new development can take place. The development phase will still take 2 years (after the research phase), but will only cost 4.4 billion Rs per year.
b) Calculate the NPV of undertaking the extra research by assuming 75% chance of success and 25% chance of failure. How does this compare to the NPV in a) and would you advice to invest in the research project or start development at once? Use a decision tree to illustrate this choice.
If successful, the technology will be used for future projects, providing an extra income at future oil fields by increasing recovery with 8 percentage points. The company estimates this as an extra addition to the NPV of a success with 5.0 billion Rs.
c) Explain why this is a real option, and how will this affect your decision about taking on the research project for the new technology?
d) What are the main concerns with the analysis in both a) and b)? How can sensitivity/ scenario analysis and monte carlo simulation help with these issues?
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any one with the Kaplan interim mock and final assessment papers for December 2012 exams can send me a copy
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