Question 1: Explain with a graph how SML is different from CML. Why CAPM equation might be more relevant than other equations when calculating required rate of return. (1000 words)
Question 2: Berry Mount manufactures a variety of Pie. The company is considering introducing a new product (Pizza Pie). The company's manager has been provided with the following information by their business analyst.
- The project has an anticipated economic life of 5 years.
- The Company plans to spend $1,250,000 on advertising campaign to boost sales.
-The Company's interest expense each year will be $550,000.
- The Company is required to purchase a new machine to produce the new product.
The machine's initial cost is $6,500,000. The machine will be depreciated on a straight - line basis over 5 years. The Company anticipates that the machine will last for 10 years; the salvage value after 5 years is $600,000.
- Six months ago the Company also paid $400,000 to a firm to do research regarding new product.
- If the Company goes ahead with the new product, it will have an effect on the Company's net operating capital.
The forecasted net working capital will be $250,000 (at time zero)
- The new product is expected to generate sales revenue of $2,000,000, 2,500,000, 3,000,000 3,500,000 and 4,000,000 in year 1, 2, 3, 4 and 5 respectively. Each year the operating cost (not including depreciation) expected to equal 25 percent of sales revenue.
- In addition the Company expects with introduction of new product, sale of other Pie increase by $550,000 after taxes each year.
- The Company's overall WACC is 8 percent. However, the proposed project is riskier than the average project; the new project's WACC is estimated to be 10 percent.
- The Company's tax rate is 30 percent.
- Find the net present value, internal rate of return, payback period, discounted payback period, and profitability index of the proposed project. Based on your analysis should the project be accepted- Discuss. (I want proper 3 paragraphs for introduction and proper referencing )