- CFA Exams
- CFA Level I Exam
- Topic 3. Corporate Issuers
- Learning Module 5. Capital Investments and Capital Allocation
- Subject 2. Capital Allocation

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**CFA Practice Question**

A project has the following expected cash flows:

0 | (125,000)

1 | 100,000

2 | 200,000

Time | Cash Flow ($)

0 | (125,000)

1 | 100,000

2 | 200,000

If the risk-free interest rate is 4 percent, expected inflation is 3 percent, the market risk premium is 8 percent and the Beta for the project is 1, the investment's net present value (NPV) is closest to ______.

A. $113,000

B. $123,725

C. $139,000

**Explanation:**The opportunity cost of capital for the investment would be the risk-free rate + the market risk premium x Beta. 4% + (8% x 1) = 12%. The NPV equals the present value (at time = 0) of the future cash flows discounted at the opportunity cost of capital (12%) minus the initial investment, or $123,725 ( = - 125,000, = 100,000, = 200,000, I = 12, solve for NPV = 123,725).

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**User Contributed Comments**
3

User |
Comment |
---|---|

Marinov |
So why do we need inflation rate here? |

ANBobby |
to trick you |

Mhmdjamal |
obtaining opportunity cost of capital(Rate of discount) by using asset pricing model |