(Updating) Consulting Cases - Investment

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NPV (Net Present Value)

Only investments with a positive NPV should be considered

CAPM (Capital Asset Pricing Model)

Usage

determine an appropriate rate when making NPV calculations.

Calculation

r = rf + β(rm – rf)

  • r = Discount rate
  • rf = Risk-free rate of return - Return Rate that can be received with a risk-free investment like U.S Treasury Bills
  • rm = Market rate of return - Return Rate that can be received by investing in a diversified portfolio (S&P 500)

β

Beta of the Investment - a measurement of the risk of an investment compared to the risk of the market as a whole.

  • β>1: Investment has more risk than the market. Example: For an investment with a β = 1.29, a 1% increase in the market means a 1.29% increase in the investment value.

  • 0<β<1: Investment will tend to move in the same direction as the market. The asset is not as sensitive to market movements. Example: For an investment with a β = .75, a 1% increase in the market means a .75% increase in the investment value.

  • β=0: The investment is not correlated with the market. “Risk-free” assets have β of 0.

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