Detailed assessment criteria: Provided a clear discussion and presentation of cash flow determination and discount rate estimation. As a result of this, a sensitivity analysis was undertaken in the attempt to determine how different beta values impact Cicero Mines investment choice, with everything else remaining constant. Conversely, the validity of these assumptions may not be entirely correct considering the recent volatility of financial markets and the lack of information on Cicero Mines, and therefore is likely to influence the investment evaluation. As such, this rate will be used as a proxy for the risk free rate in the CAPM. As Montrose Mining Group is not a publicly listed company you need to find a proxy company that reflects the risk profile of your firm. These costs will be incurred immediately. You need to report to the Board of Directors on the viability of this investment, including a clear explanation of the cash flows under analysis. Proxy Beta: Beta is the third and final part of the CAPM and since Cicero Mines is not a publically listed company, beta cannot be directly calculated from its share price data. This could impact the decision between Machine A and B, as an increased tax expense will decrease free cash flows of the project, creating a difference in calculated NPVs. Clear and logical presentation is a major challenge in report preparation. Risk-Free Rate: Brigham and Ehrhardt define the risk free rate!! You will also need to collect data to estimate the risk free rate and the expected equity risk premium. The loan repayments would involve annual payments of principle and interest over the eight year life of the project. Part 3: 5 marks You are having second thoughts about your choice of proxy company and are concerned that a wrong choice may impact on the investment decision. It should be noted that a risk free rate is only a hypothetical term as it is very difficult to achieve.
According to Brealey, Myers and Allen this value is attained on the basis of long term historical returns on the market above the risk free rate, with the underlying assumption that the monthly market returns will predict future returns. With BHP Billitons debt to equity ratio being 0.
Ten year Australian Treasury Bonds are used as a proxy for the risk free rate, due to this project being of a long-term nature. These costs will be incurred immediately. All cash flows are stated in Australian dollars. If assignments are not submitted in this way a late penalty will be applied until the document is corrected.
Therefore, the correct decision is to choose Machine B as it provides the best outcome in all calculations undertaken throughout this investment analysis. You then use the beta to estimate an appropriate discount rate for Montrose. The assignment is due on Monday 2 May at 4pm week 9.
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