CORPORATE FINANCE

Corporate Finance

Corporate Finance

Question 1

one of the fiercest early proponents of the CAPM, Fama himself, went so far as to argue that our criterion and verdict should be reversed: market pricing is not “anomalous”, but the CAPM is faulty and “Wanted, Dead or Alive”. However, the argument that Beta partially explains returns is not a vindication of the CAPM, in which Beta is the sole determinant. Because the CAPM is such a simple and attractive tool, we think that many of our colleagues want to be confused on this point. Although these arguments against the CAPM and “the way it is currently applied, for example, to estimate the cost of capital” are empirically grounded, it is worth mentioning that some authors showed its theoretical weaknesses a long time ago. For example, when the number of different securities investors can hold is limited, systematic risk cannot be the only risk paid for by the market. The equilibrium pricing equation is much more complex and leaves room to unsystematic risk.

Year

Outflow

Inflow

Cash Flow

0

310400000

-310400000

1

270000000

131543000

-138457000

2

25000000

138120150

113120150

3

30000000

145026158

115026157.5

4

35000000

152277465

117277465.4

5

40000000

159891339

119891338.6

NPV

(£29,268,813.38)

IRR

1%

Coming to IRR, the project has IRR less than the cost of capital. It means that the decision from NPV rule was correct and we have to reject the project. As per the IRR rule, we accept the project having IRR greater than the discount rate. In this case, the project have IRR less than the discount rate.

The payback period is defined as the length of time required to recover an initial investment through cash flows generated from the investment. The payback period provides some visibility as to the level of profitability of the investment in relation to time. The shorter the time period the better the investment opportunity:

As per the calculations, we can easily say that the opportunity under consideration is not feasible for Wonderland Confectionaries Inc.We have analyzed the given cash flows of this project using techniques such as Net Present Value (NPV), Internal Rate of Return (IRR) and Payback Period (PBP). The reason for analyzing this project by multiple techniques is to increase the reliability and authenticity of our forecast. From the excel sheet, we can easily see that Net Present Value of Project is less than 1. We reject the project because negative NPVs will lead to losses in the short and long-run. Recently In many real world situations, the most sophisticated managers tend to proceed in two or three steps. First they estimate the equity risk premium for the “average market risk” on the basis of the historical average market risk premium. For North America, historical market returns dating back to 1925 are compiled every year by Ibbotson Associates. Ex post risk premia above the riskless rate are also computed; their historical average is deemed representative of the average ex ante risk premium on the market portfolio. The sum of the current riskless rate (usually the rate on a government bond of the appropriate maturity) and of this average risk premium represents the cost of equity for an average ...