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CMA Final · Strategic Financial Management · Evaluation of Risky Proposals for Investment Decisions

Himalaya Power Ltd uses a risk-adjusted discount rate derived from CAPM. The risk-free rate is 8%, the expected market return is 14%, and the project's beta is 1.5. The project needs an outlay of ₹1,80,000 now and will give inflows of ₹1,17,000 at the end of Year 1 and ₹1,36,890 at the end of Year 2. What is the project's NPV at the risk-adjusted rate?

The NPV is ₹20,000. The CAPM-based risk-adjusted rate is 8% plus 1.5 times the 6% market premium, which is 17%. At 17% the two inflows each have a present value of ₹1,00,000, totalling ₹2,00,000, against an outlay of ₹1,80,000.

  1. A₹20,000Correct
  2. B₹27,964
  3. C₹45,694
  4. D₹10,194

Explanation

The risk-adjusted rate = 8% + 1.5 × (14% − 8%) = 17%. PV = 1,17,000/1.17 + 1,36,890/1.3689 = 1,00,000 + 1,00,000 = ₹2,00,000, so NPV = ₹20,000. Using 14% gives ₹27,964 and using 8% gives ₹45,694. Using 1.5 × 14% = 21% gives ₹10,194.

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