PLEASE WRITE ALL THE FORMULAS AND CALCULATIONS

Question 3 [12 points]

Consider an economy with three states which occur with probability (0.3, 0.3, 0.4). Suppose a firm has a project which generates the state dependent cash flows (100, 300, 200) at t=1. The investment costs are $180 at t=0. The market portfolio generates the payoff (100, 200, 300) and has an expected return of 10%. The risk free rate is 1%. Suppose the CAPM holds.

1. (a) What is the beta of this project? [4p]

2. (b) Explain whether the firm should conduct the project. [4p]

3. (c) Please comment on the following statement. Suppose the CAPM holds. The firm can either invest in project A or B. The firm should conduct project A if it has a higher expected return than project B. Is this statement true? [4p]