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The Rice Solar Corp. has a new investment opportunity that generates expected cash flows of $100 million per year (end of year) forever. The managers of Rice Solar are not sure what the required rate of return for the project should be, so they examine A&M Solar Inc. whose main business is very similar to the new project Rice Solar is evaluating. The expected return of the market portfolio is 7%, and the annual risk-free rate is 4%. The volatility of the market portfolio is 20%, and the covariance between the market portfolio and A&M Solar Inc. is 0.15. Assume that tax rates are equal to zero; A&M Solar and Rice Solar have no debt.
a. What is the β of the assets of A&M Solar Inc.?
b. What is the expected return of A&M Solar Inc.?
c. What is the present value of the cash flows of the new investment opportunity of Rice Solar Corp?
d. If the project requires an investment of $900 million, should Rice Solar go ahead with it? Why?
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