The Capital Assets Pricing Model

  The Capital Assets Pricing Model   ECO202: Macroeconomics          
Part I: Capital Budgeting Practice Problems a. Consider the project with the following expected cash flows:

Year	Cash flow
0	-$400,000
1	$100,000
2	$120,000
3	$850,000

• If the discount rate is 0%, what is the project's net present value?
• If the discount rate is 2%, what is the project's net present value?
• If the discount rate is 6%, what is the project's net present value?
• If the discount rate is 11%, what is the project's net present value?
• With a cost of capital of 5%, what is this project's modified internal rate of return?

 

		Discount		Discounted
Year	Cash flow	Rate	PVIF	Cash Flow
0	($400,000)	0%	1	($400,000)
1	$100,000	0%	1	$100,000
2	$120,000	0%	1	$120,000
3	$850,000	0%	1	$850,000
NPV				$670,000

 

		Discount		Discounted
Year	Cash flow	Rate	PVIF	Cash Flow
0	($400,000)	2%	1	($400,000)
1	$100,000	2%	0.9804	$98,040
2	$120,000	2%	0.9612	$115,344
3	$850,000	2%	0.9423	$800,955
NPV				$614,339

 

		Discount	Discount	Discounted
Year	Cash flow	Rate	Factor (PVIF)	Cash Flow
0	($400,000)	6%	1	($400,000)
1	$100,000	6%	0.9434	$94,340
2	$120,000	6%	0.89	$106,800
3	$850,000	6%	0.8396	$713,660
NPV				$514,800

 

		Discount		Discounted
Year	Cash flow	Rate	PVIF)	Cash Flow
0	($400,000)	11%	1	($400,000)
1	$100,000	11%	0.9009	$90,090
2	$120,000	11%	0.8116	$97,392
3	$850,000	11%	0.7312	$621,520
NPV				$409,002

  MIRR Assuming Applicable Finance Rate is 5%

		Discount	Discount
Year	Cash flow	Rate	Factor	Cash Flow
0	($400,000)	5%	1.157625	($463,050)
1	$100,000	5%	1.1025	$110,250
2	$120,000	5%	1.05	$126,000
3	$850,000	5%	1	$850,000
Positive Cash flows				$1,086,250
Negative Cash flows				($400,000)

  $1,086,250/ $400,000^1/3= 2.72^(1/3)-1=1.3951-1=39.52%      

Discount Rate	NPV
0%	$670,000
2%	$614,339
6%	$514,800
11%	$409,002

  The graph intersects the horizontal line at 45.7% When the discount rate is 0% the investment project has the highest NPV at $ 670,000, but this declines to $614,339 at 2 %, 514,800 at 6% and $ 409,002 at 11%. The NPV further declines until the discount rate is 45. 7%, and beyond this point the investment project would return negative NPV. The decision criteria is to choose an investmen...