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Porto Berhad is an all-equity firm. The company is considering the following projects: Project Beta Expected return Barcelona 0.70 11% Juventus 0.85 14% PSG 1.30 16% Chelsea 1.50 18% The T-bill rate...

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Accounting

Porto Berhad is an all-equity firm. The company is consideringthe following projects:

Project

Beta

Expected return

Barcelona

0.70

11%

Juventus

0.85

14%

PSG

1.30

16%

Chelsea

1.50

18%

The T-bill rate is 9 percent and the expected return on themarket is 12 percent.

a.Evaluate which projects have higher expected return than thefirm’s 12 percent cost of capital

b. Assess which projects would be incorrectly accepted orrejected if the firm’s overall cost of capital were used as ahurdle rate.

Pension funds pay lifetime annuities to recipients. If a firmexpects to remain in business

indefinitely, its pension obligation will resemble a perpetuity.Suppose, therefore, that you are

managing a pension fund with obligations to make perpetualpayments of RM 2 million per year

to beneficiaries. The yield to maturity on all bonds is 16%.

c. If the duration of 5 year maturity bonds with coupon rates of12% (paid annually) is 4 years and the duration of 20 year maturitybonds with coupon rates of 6% (paid annually) is 11 years, how muchof each of these coupon bonds (in market value) will you want tohold to both fully fund and immunize your obligation?

(d) What will be the par value ofyour holdings in the 20 year coupon bond?

Answer & Explanation Solved by verified expert
3.9 Ratings (603 Votes)

a) Projects Juventus , PSG and Chelsea, with expected returns of 14% ,16% and 18% respectively, have higher returns than the firm’s 12% cost of capital.
b)
Project Beta Risk Free Rate (RF) Expected Market Return R(m) Expected Return= RF + Beta x (Rm - RF) Expected return (Given) Hurdle Rate = 12% Comparing With Expected Return Lesser than 12% are rejected and greater than 12% are accepted.
Barcelona 0.7 9.00% 12.00% 11.10% > 11.00% Correctly Rejected 11.10 %< 12%
Juventus 0.85 9.00% 12.00% 11.55% < 14.00% Incorrectly Rejected 11.55%<12.0%
PSG 1.3 9.00% 12.00% 12.90% < 16.00% Correctly Accepted 12.90%>12%
Chelsea 1.5 9.00% 12.00% 13.50% < 18.00% Correctly Accepted 13.50%>12%
Using the firm’s overall cost of capital as a hurdle rate, accept projects PSG and Chelsea.

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