Company: Sportball Plc
Products :Footballs and basketballs
Capital to invest :ÃÂ£ 100.000
Project 1: Manufacture Shoes
Project 2:Manufacture Shirts
1st Year2nd Year3rd Year
Shoes ÃÂ£ 80,000 ÃÂ£ 75,000 ÃÂ£ 25,000
Shirts ÃÂ£ 60,000 ÃÂ£ 50,000 ÃÂ£ 50,000
Rate on a Gov Bond(The risk-free rate):5%
FTSE 100 (Expected rate of the market):8%
Shoes Leader's ?:0.95
Shirts Leader's ?:1.1
a)Which project should Sportball plc choose?
In order to be able to decide anyone of the projects, first of all we must analyze the ÃÂ previously that we will choose to evaluate.
Therefore, we have to be very careful in this decision, since on this, could depend the success of the project evaluation.
To choose the appropriate beta, we must study in what segment or sector " Sportball Plc " is going to get in, since this will give us the risk parameter beta, thus to calculate the correct expected rate to make our analysis.
Assumption 1: As the company will get into a new branch of the sport accessories, which could be the Sport shoes or Sport Shirts, we will use the ? of each industry to calculate the expected rate and then determinate the feasibility of the projects:
However as illustration, it will show how would be the appraisal with Sportball's ?:
Market -risk premium
We call Market -Risk premium to the difference between the expected rate of the market and the risk free rate so 0.08 - 0.05 = 0.03
Where 0.03 will be our Market -Risk premium to evaluate de projects.
Calculating the Expected Rates
We know that the expected return on the stock, using CAPM, is:
Using Sportball's ÃÂ (0.90) will have:
= 7.70 % (1)
Using Shoes leader's ÃÂ (0.95) will have:
= 7.85 % (2)
Using Shirts leader's ÃÂ (1.1) will have:...