Assignment on CAPM (Capital Asset Pricing Model)

Question 1-Part a
CAPM
Expected Return = Risk free Rate + Beta * (Expected Market Return- Risk Free Rate)
 If expected return CAPM is greater Investors Return, then share is overpriced.
 If expected return CAPM is Investors Return, then share is underpriced.
 If expected return CAPM is equal to Investors Return, then share is overpriced
Share Beta Investors Return CAPM
A 1.5 14% 11% Underpriced
B 0.6 8% 6% Underpriced
C 1.2 9% 9% Correctly priced
D 1.8 10% 12% Overpriced
Part b
Need to construct a portfolio such that Wa *14% + (1-Wa) *8%≥ 10%
Wa = 33.33%. Therefore construct a portfolio with at least 33.3% shares A
Part c -e
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B C D E
Year ProjectA ProjectB ProjectC
0 -20000 -40000 -70000
1 18000 5000 30000
2 18000 10000 30000
3 18000 30000 40000
4 80000 50000
5 100000 180000
NPV =C4+NPV($D$1,C5:C9) =D4+NPV($D$1,D5:D9) =E4+NPV($D$1,E5:E9)
IRR =IRR(C4:C8,10%) =IRR(D4:D9,30%) =IRR(E4:E9,50%)
ProfitabilityIndex =NPV($D$1,C5:C9)/-C4 =NPV($D$1,D5:D9)/-D4 =NPV($D$1,E5:E9)/-E4

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B C D E
Year Project A ProjectB ProjectC
0 (20,000) (40,000) (70,000)
1 18,000 5,000 30,000
2 18,000 10,000 30,000
3 18,000 30,000 40,000
4 80,000 50,000
5 100,000 180,000
NPV 23,233 101,374 143,085
IRR 72.45% 55.51% 56.01%
ProfitabilityIndex 2.16 3.53 3.04
c. Net Present Value
Project C has the highest NPV-143,085, therefore it is the best. It is then followed by
project B with NPV -101,374 ,and lastly project A with NPV -23,233.
d. Payback Period
PBP A = 20,000/18,000 = 1.11
PBP B= 2 + (40,000-15,000)/30,000 = 2.83
PBP C= 2 + (70,000-60,000)/40,000 = 2.25
We observe Projects A and C have a payback period less than acceptance criteria 2.75,
therefore Sharpe should accept both Project A and project C..
e.IRR and Profitability index
IRR is the rate or return that NPV = 0
Profitability Index = PV of future cash flows/initial investment
A –IRR- 72.45% and PI- 2.16
B- IRR- 55.51% and PI- 3.53
C- IRR- 56.01% and PI- 3.04

Question 2
Part a
i.20 year Loan Term
The Loan Sam will borrow is 630,000 (90% *700,000)
PV= 630,000
i= 3.5% pa
n=20 years
Annual Payments, PMT=?
We need to compute PMT using annuity formula below
PV = PMT*( 1−(1+i ¿¿¿−n)
i )
630,000= PMT*( 1−(1+3.5 % ¿¿¿−20)
3.5 % )
Solve PMT
PMT = 44,327.478
ii.25 year Loan Term
The Loan Sam will borrow is 630,000 (0.9*700,000)
PV= 630,000
i= 3.5% pa
n=25 years
Annual Payments, PMT=?
We need to compute PMT using annuity formula below
PV = PMT*( 1−(1+i ¿¿¿−n)
i )
630,000= PMT*( 1−(1+3.5 % ¿¿¿−25)
3.5 % )
Solve PMT= 38,224.642