An all-equity firm is considering the following projects: The T-bill rate is 5 p

Question

An all-equity firm is considering the following projects:

The T-bill rate is 5 percent, and the expected return on the market is 12 percent.

Compared with the firm's 12 percent cost of capital, Project W has a (higher/lower)  expected return, Project X has a (higher/lower) expected return, Project Y has a (higher/lower) expected return, and Project Z has a (higher/lower) expected return.

Project W should be (accepted/rejected) , Project X should be   (accepted/rejected), Project Y should be  (accepted/rejected), and Project Z should be   (accepted/rejected).

If the firm's overall cost of capital were used as a hurdle rate, Project W would be (correctly accepted/correclty rejected/incorrectly accepted/incorrecltyrejected), Project X would be (correctly accepted/correclty rejected/incorrectly accepted/incorrecltyrejected), Project Y would be (correctly accepted/correclty rejected/incorrectly accepted/incorrecltyrejected), and Project Z would be (correctly accepted/correclty rejected/incorrectly accepted/incorrecltyrejected).

An all-equity firm is considering the following projects:

Explanation / Answer

Ke = Rf + Betal(Rm -Rf)

for project W : Ke = 5% + 0.61(12%-5%) = 9.27%

for project X : Ke = 5% + 0.0.85(12%-5%) = 10.95%

for project Y : Ke = 5% + 1.17(12%-5%) = 13.19%

for project Z : Ke = 5% + 1.55(12%-5%) = 15.85%

a) Project W: Lower Expected return

Project X: Lower Expected return

Project Y: Higher Expected return

Project Z: Higher Expected return

b) Project W: Rejected

Project X: Rejected

Project Y: Accepted

Project Z: Accepted

c) Project W: Correctly Rejected

Project X: Correctly Rejected

Project Y:Correctly Accepted

Project Z: Correctly Accepted

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