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Assessing the Value of Investment Projects using Arbitrage Pricing Theory

## Problem 1: Cost of Equity-CAPM using Arbitrage Pricing Theory

This competency assessment addresses assessing the value of investment projects. The Arbitrage Pricing Theory helps calculate required stock returns considering a number of factors. In this Assignment, you will apply Arbitrage Pricing Theory to a business scenario. Prepare this Assignment as a Word document. List each question followed by your answer

1. Complete problem: Cost of Equity-CAPM

XYZ, Inc. has a beta of 0.8. The yield on a 3-month T-bill is 5%, and the yield on a 10-year T-bond is 7%. The market risk premium is 5.5%, and the return on an average stock in the market last year was 20%. What is the estimated cost of common equity using the CAPM? Show your work.

2. Complete problems: NPV, IRR, MIRR, Profitability Index, Payback, Discounted Payback

A project has an initial cost of \$60,000, expected net cash inflows of \$10,000 per year for 8 years, and a cost of capital of 12%. Show your work.

• What is the project’s NPV? (Hint: Begin by constructing a timeline).

• What is the project’s IRR?

• What is the project’s MIRR?

• What is the project’s PI?

• What is the project’s payback period?

• What is the project’s discounted payback period?

3.Your division is considering two investment projects, each of which requires an up-front expenditure of 20 million. You estimate that the investment will produce the following net cash flows:

• What are the two project’s net present values, assuming the cost of capital is 5%? 10%? 15%?

• What are the two projects’ IRRs at these same costs of capital?