Homework 5: Adjusting for project risk 2 (Q) The managers of JJ\'s Enterprises a

Question

Homework 5: Adjusting for project risk 2 (Q) The managers of JJ's Enterprises are trying to determine the company's optimal capital budget for the upcoming year. JJ's is considering the following projects: The company estimates that its WACC is 11 percent. All projects are independent. The company adjusts for risk by adding 2 percentage points to the WACC for high-risk projects and subtracting 2 percentage points from the WACC for low-risk projects Which of the projects will the company accept? Risk High Average Low High Average Low Low Rate of Return 168 14 12 Project Size $200,000 500,000 400,000 300,000 100,000 200,000 400,000 10 10

Explanation / Answer

Project Rate of return Risk Company WACC Adjustment Factor Required rate of return Decision A 16% High 11% 2% 13% Accepted B 14% Average 11% 0% 11% Accepted C 12% Low 11% -2% 9% Accepted D 11% High 11% 2% 13% Rejected E 10% Average 11% 0% 11% Rejected F 10% Low 11% -2% 9% Accepted G 7% Low 11% -2% 9% Rejected Note: For decision purpose rate of return of project is compared with the required rate of return. Please hit the like button if the answer helped you else leave a comment for further clarification. Thank you! All the best!

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