An enterprise is considering investing in a building project costing GHS 150,000. The following cash flows are expected from the project. The beta of the project is 1.15 and the market return is 18%. The risk-free rate is 12%.
Year GHS
0 (150,000)
1 50,000
2 55,000
3 90,000
4 105,000
a) What is the expected return/cost of equity on this project?
b) Mabel Enterprise is a levered entity with a percentage of debt to equity ratio of 4:6. If the interest rate on a bank loan is 20% and the cost of equity is computed in (a), what will be the NPV of the investment?
c) What is the IRR for the project?
d) What will be your overall advice concerning the viability of the project?
To calculate the expected return/cost of equity on the project, you can use the Capital Asset Pricing Model (CAPM), which is commonly used to estimate the required rate of return on equity. The formula for the CAPM is as follows:
In this case:
* Risk-Free Rate (Rf) = 12%
* Beta (β) = 1.15
* Market Return (Rm) = 18%
Plug these values into the formula:
Cost of Equity (Re)=12%+1.15×(18%−12%)
Cost of Equity (Re)=12%+1.15×6%
Cost of Equity (Re)=12%+6.9%
Cost of Equity (Re)=18.9%
Therefore, the expected return/cost of equity on this project is 18.9%. This is the rate of return that the enterprise would require to compensate for the risk associated with the project, given its beta and the overall market conditions.
Rm 18%
Rrf 12%
Beta 1,15
Re 18,9%
ER 1
DR 0
Rd 0
Tax rate 0
WACC 18,9%
Year 0 1 2 3 4
NCF $-150.000,00 $50.000,00 $55.000,00 $90.000,00 $105.000,00
SUM NCF $150.000,00
NPV € 37.035,45
IRR 29,6%
PBP 3 years
BET 3 years
a)Re=0.189
b)WACC=0.1963
NPV=34047.22$
c)IRR=0.2956
d) it is a profitable project
@Stavros Kourtis
what is the tax rate to calculate the tax shield in the WACC?
WACC= We*Ke+Wd*Kd*(1-tax rate). In our case we have no information for the tax rate, thus we consider it zero.
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