What is the expected rate of return of project

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Reference no: EM131188988

Your firm is planning on introducing a new product. Once the product is developed, at the end of 1 year, you expect to sell it for a price p, with expected value p = $24M . However, this sale price will depend on the market at the time. By examining the histories, it is determined that the final sales price p is correlated with the market return as

E[(p - p-bar)(r - r-bar)] = $20MSigma-Square

To develop the process, you must invest in a research and development project. The cost c of the project will be known shortly after the project is begun. The current estimate is that the cost will be either c=$20M or c=$16M, and each of these is equally likely. (This uncertainty is uncorrelated with the final price and is also uncorrelated with the market). Assume that the risk free rate is rf=9% and the expected return of the market rM=33%.

1) What is the expected rate of return of this project?

2) What is the beta of this project?

3) Is this an acceptable project based on a CAPM criterion? In particular what is the excess rate of return above the predicted by the CAPM?

Reference no: EM131188988

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