β= 1.
5 Project cost of capital: E(r_i)=
E(r_m)= 8% E(r_i) =
r_f = 4%
Year -> 0 1
Capital Expenditure -1,200,000
Cash flow $ 340,000
10% PV @ r=10% $ -1,200,000 $ 309,091
NPV (Project) = $ 88,867.5
NPV (Project) > 0 Furniture Depot should take this project
r_f + β [E(r_m) -r_f] E(r_i)=
10.0% ρ (i_m)
r_f =
σ(i)=
2 3 4 5 E(r_m)=
σ(m)=
$ 340,000 $ 340,000 $ 340,000 $ 340,000 Where,
r= rate
$ 280,992 $ 255,447 $ 232,225 $ 211,113
t
25% β = σ(i_m) * ρ (i_m)/ σ(m)
0.80
3% β= 1.33
25%
20%
15%
According to CAPM, the actual return (25%) has been lesser than
Accordng to CAPM
Project cost of capital: E(r_i)= r_f + β [E(r_m) -r_f]
E(r_i) = 25.7%
Average return " E(r_)
eturn (25%) has been lesser than expected returns (25.7%) Standard dev. "σ
Correlation
W_d =
W_e =
Average return " E(r_)
Standard dev. "σ
Correlation
Correlation
Weightage
Correlation
Standard dev
Standard dev
Standard dev
E(r_i)=
E(r_i)=
Standard deviation:
W_d 25%
W_e 55%
W_c 20%
The expected return for crypto (2%
standalone investment, it would ha
Since crypto has a negative correla
crypto being a volatile asset by its
Risk free Debt Equity
age return " E(r_) 3% 6% 10%
ndard dev. "σ 0% 12% 20%
ρ -0.20
0.3 E(r_i)= W_d*E(r_d)+W_e*E(r_m)
0.7 E(r_i)= 8.8%
Standard Dev σ_p= Sqrt (w_D² * σ_D² + w_E² * σ_E² + 2 * w_D * w_E * σ_D *
σ_p= 13.7%
Sharp ratio
Part 1: E(r_p)= 8.80%
r_f= 3.00%
σ_p 13.74%
Sp= 0.422
Part 2: E(r_c)= 2.00%
r_f= 3.00%
σ_c 25.00%
Sc= -0.040
# A negative Sharpe ratio means that the investment is yielding returns below
# A negative Sharpe ratio (Sp = -0.040) suggests that the project is not a good investment b
compensating for the risk taken,
Risk free Debt Equity Crypto
ge return " E(r_) 3% 6% 10% 2.0%
ard dev. "σ 0% 12% 20% 25.0%
ρ(c_e) -0.50
ρ(c_d) -0.30
W 25% 55% 20%
ρ(d_e) -0.20
σ(d) 12% Standard dev σ(d_e) -0.48%
σ(e) 20% Standard dev σ(c_d) -0.90%
σ(c) 25% Standard dev σ(c_e) -2.50%
W_d*E(r_d)+W_e*E(r_m)+W_c*E(r_c)
7.4%
dard deviation: Variance=
W_d W_e W_c σ_p= 8.8%
25% 55% 20%
0.0009 -0.0007 -0.00045
-0.00066 0.0121 -0.00275
-0.00045 -0.00275 0.0025
Part 3: E(r_c)= 7.40%
r_f= 3.00%
σ_c 8.82%
Sc= 0.499
return for crypto (2%) is lower than both debt and equity, while its risk (25%) is much highe
estment, it would have a low or negative Sharpe ratio, meaning a poor risk-return tradeoff
as a negative correlation with both debt & equity, it helps to reduce the overall portfolio ris
volatile asset by itself. This diversification benefit makes crypto a valuable addition to the
Debt Equity
E('r) 6% 12%
Amount 100 250
Weightage 28.6% 71.4%
Before Tax WACC 10.3%
If we adjust the tax in Debt, then we need not factor in t
that case the Aftr tax WACC can be used for calculating
After tax WACC 9.9%
2 * w_D * w_E * σ_D * σ_E * ρ_DE)
returns below the risk-free rate
not a good investment because it’s not
(25%) is much higher. As a
risk-return tradeoff on its own.
e overall portfolio risk, despite
able addition to the portfolio.
Tax 21%
need not factor in the Interest on Debt in Net taxable income computation, then in
sed for calculating required rate of return
0 1
0 Capital Expenditure $ -35,000,000
1 Revenue $ 7,500,000
2 Expenses $ 2,000,000
3 Interest $ 600,000
4= 1-2-3 EBT $ 4,900,000
5= Rate *4 Taxes @ 21% $ 1,029,000
6= 4-5 Net Income $ 3,871,000
7= 3+6 Op. Cash flow $ 4,471,000
8= 7+0 Total CF $ -35,000,000 $ 4,471,000
C= $ 4,471,000
PV of Cash-inflow:- Annuity of C for 20 yrs @ r=10.3%
C/r [1- 1/(1+r)^t]
PV of Cash-inflow:- $ 37,333,473
NPV = $ 2,333,473
Total investment =
Debt
Equity
2 …..20 Debt 6%
Interest
$ 7,500,000 $ 7,500,000
$ 2,000,000 $ 2,000,000
$ 600,000 $ 600,000
$ 4,900,000 $ 4,900,000
$ 1,029,000 $ 1,029,000
$ 3,871,000 $ 3,871,000
$ 4,471,000 $ 4,471,000
$ 4,471,000 $ 4,471,000
35000000
10000000
25000000
$ 10,000,000
$ 600,000
The formula for CAPM is:
r = r_f+β×(r_m−r_f)
Where:
r = Required return (discount rate)
Risk-free rate = r_f=3%
Market return = r_m= 9% or 0.09
β = Beta of the division
Discount Rate for Telecommunications Division
r_Tel= 0.03 + 0.50×(0.09−0.03)
r_tel= 6.0%
Discount Rate for Media Division
r_Tel= 0.03 + 1.05×(0.09−0.03)
r_med= 9.3%
Overall Discount Rate for the Firm
r_company= 0.60×r_tel+0.40×r_med
r_company= 7.3%
Final Answers:
1. Telecommunications Discount Rate: 6%
2. Media Discount Rate: 9.3%
3. Overall Company Discount Rate (for acquisition)
Part a
tions Division (60% of the firm)
(40% of the firm)
Part b
(for acquisition): 7.32%
Risk free Global crisis hedge S&P 500
Average return " E(r_) 2.5% 2% 8%
Standard dev. "σ 0% 8% 17%
Correlation ρ -0.75
Global crisis hedge Sharp ratio S&P 500
E(r_g)= 2.00% E(r_sp)=
r_f= 2.50% r_f=
σ_g 8.00% σ_sp
S_g= -0.063
Quantitative Explanation:
# On a standalone basis, the Global Crisis Hedge Fund seems less attractive than the S&P 500 due to
# A negative Sharpe ratio indicates that the fund’s returns are below the risk-free rate when consider
# The correlation between the hedge fund and the S&P 500 is -0.75. This negative correlation implies
Qualitative Explanation:
The Global Crisis Hedge Fund invests in alternative assets such as precious metals and water ri
In periods of market downturns or high volatility in equities (like the S&P 500), having exposure t
Investors who are risk-averse or concerned about future market instability might allocate part of the
Sharp ratio
8.00%
2.50%
17.0%
S_sp= 0.324
n the S&P 500 due to the negative Sharpe ratio.
ee rate when considering its volatility (risk).
ve correlation implies that the hedge fund can act as a diversifier in a broader portfolio, reducing overall portfol
metals and water rights, which tend to perform well during economic crises or inflationary periods. Inve
0), having exposure to uncorrelated or negatively correlated assets can significantly reduce losses and pr
ht allocate part of their portfolio to this hedge fund as a way to manage and mitigate systemic risks
educing overall portfolio risk.
tionary periods. Investors may value this as a hedge against market volatility or unexpected economic s
y reduce losses and protect wealth.
stemic risks.
nexpected economic shocks.
