Your firm is considering a new risky capital expansion program. Based on the information in Exhibit 1, answer the following questions.

a. What is the beta of the project?

b. On a graph paper draw the security market line. Carefully label your graph indicating the intercept, slope, and the variables plotted on each

axis.

c. Using (a) and (b) should the project be accepted?

Exhibit 1

There are two 'states of the world' -- state 1 represents a mild recovery and state 2 represents a strong recovery. The probabilities of these alternative future 'states of the world' are given in column 2. Estimates of the return on the market and the project are given in columns 3 and 4 respectively.

Summary of information

(1) (2) (3) (4)

State of World Subjective Return on Return on

Probability Market project

(Ps) (Rms) (Rps)

S = 1 0.7 0.10 0.00

S = 2 0.3 0.30 0.40

Rf = 10%

Answer rating: 100% (QA)

SOLUTION a To calculate the beta of the project we need to first calculate the expected return of th... View the full answer