AFC2140

[|ll|lll|]

(from 2011 Sem 1 Exam)

Question 4
Randell Corp. is considering the project of manufacturing of a new dish washer. This is a 7 year project. It is expected that demand for the product will increase over time. The initial outlay of the project is $850,000. The company’s financial manager has made the following estimates of expected cash flows for the project.

Net annual cash flows are provided in the following table
                                                               High Demand                         Low Demand
Net cash flows p.a. for first 3 years            $250,000                             $120,000
Net cash flows p.a. for next 4 years           $350,000                             $210,000

The finance manager believes that the probability of high demand for the dish washer in the first 3 years in the market will be 0.6. If demand is high in the first 3 years the manager believes there is a 0.5 probability that demand will remain high in the following 4 years. However if demand is low, management believes that there is a 0.85 probability that it will remain low. The required return for this project is 12%.

(ii) Use the NPV (net present value) method to determine if the project should be undertaken. What is the value of the NPV for this project? Should the project proceed?

Answer says NPV = 188,527.90, which is higher than what I got.
Thoughts?

[jackson1234]

Nope same answer.

[TrueTears]

what's the  implication if beta (from CAPM MODEL) is negative?

Define to be the random variable of the returns of some market (aggregate) index and define to be the random variable that denotes the returns on some (general) financial asset. Then it can be shown that:



where denotes the covariance and denotes the variance.

The denominator in the above expression can be interpreted as a standardizing factor and is always positive. The numerator denotes the sign of .

Thus if implying that the returns on the financial asset generally move in the opposite direction when compared to the returns on the aggregate index.

[|ll|lll|]

Define to be the random variable of the returns of some market (aggregate) index and define to be the random variable that denotes the returns on some (general) financial asset. Then it can be shown that:



where denotes the covariance and denotes the variance.

The denominator in the above expression can be interpreted as a standardizing factor and is always positive. The numerator denotes the sign of .

Thus if implying that the returns on the financial asset generally move in the opposite direction when compared to the returns on the aggregate index.

Thanks TT! This means that financial asset has a lower risk than the risk-free market asset, and since beta is a measure of systematic risk, what would this mean by having a negative systematic risk?

[TrueTears]

This means that financial asset has a lower risk than the risk-free market asset

The word "risk" does not have an universal nor well-defined definition in finance. Indeed, you need to define precisely (by that I mean mathematically) what you mean by "risk" before you use the word (hence why I avoided it in my explanation). There have been seminal papers that have shown to encapsulate all kinds of risk: systematic, systemic, idiosyncratic, non-volatility and the list goes on. In this case, you cannot make any assumptions regarding the 'risk' of the financial asset relative to the market asset just from the sign of .

Since beta is a measure of systematic risk, what would this mean by having a negative systematic risk?

Similarly, there is no universal agreement as to what kind of 'risk' captures. Mathematically, it can be shown fits into many models of 'risk' including VaR, CoVaR, MES, SRISK, DIP etc. Each of the theoretical papers that propose these models measure 'risk' from a different perspective. Empirically, there are evidence that plays no role in diversification in emerging markets (there are a few seminal JF papers on this) and strangely enough, sometimes has no explanatory power at all in FF3F or a momentum capturing model. So the result today is that is just simply a mathematical measure of covariance; trying to generalize the meaning of has been well documented in previous papers and there has not been any universal agreement (similar to all other areas of finance).

Furthermore, systematic risk itself is not well defined either. There are many models that attempt to capture "systematic risk" through the use of: Granger-causality tests, extreme value theory, logit regressions, GARCH time varying models, stochastic volatility processes. Some document the existence of systematic risk, some do not. Some define systematic risk in terms of skewness and standard deviation, some define it simply as a loss threshold. Thus, it is inappropriate to determine any relationships of with systematic risk.

[Furbob]

may I ask how to get the answer to the OP question - couldn't do it myself

*looks at TT*

[Fyrefly]

may I ask how to get the answer to the OP question - couldn't do it myself

*looks at TT*

Pfft... I'm good for something too, y'know.
But only if you can read my handwriting.

[Furbob]

^ y-you remember things you studied from many-a-semesters ago?

:O

[Cappuccinos]

Can someone please upload the 2013 S2 unit guide for this unit? Thanks!

[Reckoner]

Enjoy

[Cappuccinos]

Thank you!!!!