Maritsa Plcs Using the Capital Asset Pricing Model Essay

Maritsa Plcs Using the Capital Asset Pricing Model - Essay Example Using the Capital Asset Pricing Model, the cost of capital is computed as: where: kc is the cost of capital; krf is the risk free rate; ß is the systematic risk of the common stock’s return relative to the market as a whole; and km-krf is the market risk premium, which is equal to the difference in the expected rate of return for the market as a whole2. In order to choose the most profitable investment to be pursued, the Net Present Value (NPV) technique will be used. This method of capital budgeting is widely used because of its recognition of the time value of money3. Thus, annual cash flows will be discounted order to arrive at their present values.Table 1 shows the computation of NPV for the first option which is to renew the rent contract and extend the facility for higher production. It should be noted that the values are expressed in unit  £. It can be seen that the rent payments are adjusted each year to take into account the annual 5% inflation. The NPV for Option 1 is computed as - £2,562,594. Table 2 shows the computation of NPV for the second option which is to purchase a larger facility to accommodate the increasing demand for the products. Like in the first option, all values are expressed in unit  £. Consistent with the case, this paper assumes that the company is able to secure financing through five-year debe nture with an 11.5% annual interest. It is also assumed that the company borrows the whole amount that it used to purchase the building which is equivalent to  £2,500,000. This paper also assumes that interest payments are taxable thus; it opts to deduct the tax shield from interest payments in the cash outflow. This paper also assumes that the building will be sold at  £5,000,000 after the ten-year period. The computed NPV for the ten-year period is - £1,674,701.