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Chapter 20

Question 4

The CAPM

Brixit Co is an all equity company with a beta of 1.4. It is appraising a one year
project with requires an outlay now of $5,000 and will return cash in one year
with a value ofT $6,000. The project has a beta of 1.2. Rf is 6% and Rm is
14%.

Calculate the firm’s current cost of equity capital, the minimum required return
of the project and determine whether the project is worthwhile.

Current cost of equity capital = 6 + 1.4 × (14 – 6) = 17.2%

Minimum return from the project = 6 + 1.2 × (14 – 6) = 15.6%

-1
PV of year 1 cash flow = cash flow × (1 + r)
-1
NPV of project at 15.6% = $(5,000) + $6,000 × 1.156

NPV = $190

With a positive NPV at the minimum required rate of return, the project is
worthwhile.

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