APV and Sensitivity for Project Appraisal

$(1)$ APV

Worked Example $1$:

A company operating in the insurance industry is considering whether to diversify by investing in a project in the transport industry.

The company has a gearing ratio of $30\%$ debt and $70\%$ equity, and its equity beta is $0\mathrm{.}940.$ Its debt capital is risk$-$free.

The transport industry has an average equity beta of $1\mathrm{.}362,$ and firms in the transport industry on average have a gearing ratio of $40\%$ debt to $60\%$ equity.

The risk$-$free rate of return is $5\mathrm{.}3\%$ and the expected market return is $8\mathrm{.}3\%.$

The rate of taxation on profits is $23\%.$

The cash flows of the project after tax will be:

Year $0$: $$(600,000)$

Years $1-3$: $$250,000$

Required: Calculate the base case NPV$.$

Worked Example $2$:

A company operating in the manufacturing sector is considering whether to diversify by investing in a project in the healthcare sector.

The company has a gearing ratio of $25\%$ debt and $75\%$ equity, and its equity beta is $1\mathrm{.}1.$ Its debt capital is risk$-$free.

The healthcare industry has an average equity beta of $1\mathrm{.}5,$ and firms in the healthcare industry on average have a gearing ratio of $50\%$ debt to $50\%$ equity.

The risk$-$free rate of return is $4\mathrm{.}5\%$ and the expected market return is $7\mathrm{.}5\%.$

The rate of taxation on profits is $25\%.$

The cash flows of the project after tax will be:

Year $0$: $$(800,000)$

Years $1-4$: $$300,000$

Required: Calculate the base case NPV$.$

$1$