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Project Evaluation Using Capm Essay

1753 words - 7 pages

Data:Company: Sportball PlcProducts :Footballs and basketballsCapital to invest :£ 100.000Project 1: Manufacture ShoesProject 2:Manufacture ShirtsProjectRevenues1st Year2nd Year3rd YearShoes £ 80,000 £ 75,000 £ 25,000Shirts £ 60,000 £ 50,000 £ 50,000Rate on a Gov Bond(The risk-free rate):5%FTSE 100 (Expected rate of the market):8%Sportball's ?:0.90Shoes Leader's ?:0.95Shirts Leader's ?:1.1a)Which project should Sportball plc choose?In order to be able to decide anyone of the projects, first of all we must analyze the ß previously that we will choose to evaluate.Therefore, we have to be very careful in this decision, since on this, could depend the success of the project evaluation.To choose the appropriate beta, we must study in what segment or sector " Sportball Plc " is going to get in, since this will give us the risk parameter beta, thus to calculate the correct expected rate to make our analysis.Assumption 1: As the company will get into a new branch of the sport accessories, which could be the Sport shoes or Sport Shirts, we will use the ? of each industry to calculate the expected rate and then determinate the feasibility of the projects:However as illustration, it will show how would be the appraisal with Sportball's ?:Market -risk premiumWe call Market -Risk premium to the difference between the expected rate of the market and the risk free rate so 0.08 - 0.05 = 0.03Where 0.03 will be our Market -Risk premium to evaluate de projects.Calculating the Expected RatesWe know that the expected return on the stock, using CAPM, is:Using Sportball's ß (0.90) will have:= 7.70 % (1)Using Shoes leader's ß (0.95) will have:= 7.85 % (2)Using Shirts leader's ß (1.1) will have:= 8.30 % (3)Project EvaluationUsing Sportball's ß=0.90, = 7.70%:SHOES PROJECT 1PeriodDF( )Cash FlowPV01-£ 100,000 -£ 100,00010.9285 £ 80,000 £ 74,28020.8621 £ 75,000 £ 64,65930.8005 £ 25,000 £ 20,012NPV£ 58,952IRR 44.09%SHIRTS PROJECT 2PeriodDF( )Cash FlowPV01-£ 100,000 -£ 100,00010.9285 £ 60,000 £ 55,71020.8621 £ 50,000 £ 43,10630.8005 £ 50,000 £ 40,024NPV£ 38,841IRR28.89%Here we can see clearly, that both of them have a positive NPV and a higher rate or return than the expected.Assumption 2: As the company has just £100.000 to invest in the new project, we have to choose the one which creates a higher value to investors or shareholders, thus in this case we would take the project 1, manufacturer Sport Shoes, because its NPV and IRR.Assumption 3: Now we will evaluate the projects with ? and the rate of each market leader respectively:Using the market shoes leader's ß=0.95 and = 7.85%:SHOES PROJECT (1)PeriodDF( )Cash FlowPV01-£ 100,000 -£ 100,00010.9272 £ 80,000 £ 74,17720.8597 £ 75,000 £ 64,47930.7971 £ 25,000 £ 19,929NPV£...

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