An all-equity firm is considering the following projects: Project Beta IR .67 9.

Question

An all-equity firm is considering the following projects: Project Beta IR .67 9.5 % 74 10.6 Y 1.37 14.1 Z 1.48 171 The T-bill rate is 5.1 percent, and the expected return on the market is 12 percent. Compared with the firm's 12.1 percent cost of capital, Project W has a expected return, Project X has a expected return, Project Y has a expected return, and Project Z has a expected return. Project W should be Project X should be

Explanation / Answer

Project Treasury Bill Rf Beta Market Return Expected Return = Rf + Beta x RM - RF a) IRR b) Hurdle Rate = 12.1% Comparing With Expected Return Lesser than 12.1% are rejected and greater than 12.1% are accepted. W 5.10% 0.67 12.10% 9.79% Lower 9.50% Accept Incorrectly Rejected 9.79%< 12.1% X 5.10% 0.74 12.10% 10.28% Lower 10.60% Reject Correctly Rejected 10.28%12.1% Z 5.10% 1.48 12.10% 15.46% Higher 17.10% Accept Correctly Accepted 15.46%>12.1% Compared with the firm's 12.1 percent cost of capital, Project W has a lower expected return, Project X has a lower expected return, Project Y has a higher expected return, and Project Z has a higher expected return Project W should be accepted, Project X should be rejected, Project Y should be accepted, and Project Z should be accepted. If the firm's overall cost of capital were used as a hurdle rate, Project W would be incorrectly rejected, Project X would be correctly rejected, Project Y would be correctly accepted, and Project Z would be correctly accepted.

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