Consider an economy with three states which occur with probability (0.2, 0.2, 0.6). Suppose a firm...

Transcribed Image Text:

Consider an economy with three states which occur with probability (0.2, 0.2, 0.6). Suppose a firm has a project which generates the state dependent cash flows (100, 240, 220) at t=1. The investment costs are 170 at t-0. The firm has 170 at t-0. The market portfolio generates the payoff (200, 230, 260) and has an expected return of 10%. The risk free rate is 2%. Suppose the CAPM holds. (a) What is the beta of this project? [4p] (b) What is the net present value of the project? Explain whether the firm should conduct the project. [2p] Consider an economy with three states which occur with probability (0.2, 0.2, 0.6). Suppose a firm has a project which generates the state dependent cash flows (100, 240, 220) at t=1. The investment costs are 170 at t-0. The firm has 170 at t-0. The market portfolio generates the payoff (200, 230, 260) and has an expected return of 10%. The risk free rate is 2%. Suppose the CAPM holds. (a) What is the beta of this project? [4p] (b) What is the net present value of the project? Explain whether the firm should conduct the project. [2p]

Answer rating: 100% (QA)

To calculate the beta of the project we need to determine the covariance between the projects cash flows and the market portfolios returns as well as ... View the full answer