Question

Laramie Labs uses a risk-adjustment when evaluating projects of different risk. Its overall (composite) WACC is 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Laramie evaluates low-risk projects with a risk-adjusted project cost of capital of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects:

Answer 1

The correct option is 3. A, B, and D.

The set of projects would maximize shareholder wealth is A, B, and D.

What is low-risk projects?

Low risk suggests that there won't be a significant negative effect on the organization should the project fail.

The computation of the provided data is displayed below, depending on the circumstance:

To determine which projects set would maximize shareholder wealth, we must compare the WACC to the anticipated return.

Below are some specific risk WACC (needed return) (%), expected return (%), and accept or reject reasons-

• High 12 Project A 15 Select WACC is less profitable than anticipated.
• The return for Project B's Average 10-12 Select WACC is less than anticipated.
• WACC for Project C High 12/11 Reject is greater than anticipated return.
• Low Project D 8-9 Select WACC is less profitable than anticipated.
• WACC for Project E Low 8 6 Reject is higher than anticipated return.

Therefore, in order to maximize shareholder wealth, option C (projects A, B, and D) should be chosen.

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The complete question is-

Laramie Labs uses a risk-adjustment when evaluating projects of different risk. Its overall (composite) WACC is 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Laramie evaluates low-risk projects with a WACC of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects:

Project Risk Expected Return

A High 15%

B Average 12%

C High 11%

D Low 9%

E Low 6%

Required:

Which set of projects would maximize shareholder wealth?

1. A and B.
2. A, B, and C.
3. A, B, and D.
4. A, B, C, and D. A, B, C, D, and E.