Question

A company estimates that an average-risk project has a WACC of 10 percent, a below-average-risk project has a WACC of 8 percent, and an above-average-risk project has a WACC of 12 percent. Which of the following independent projects should the company accept?
A) Project A has average risk and an IRR = 9 percent.
B) Project B has below-average risk and an IRR = 8.5 percent.
C) Project C has above-average risk and an IRR = 11 percent.
D) All of the projects above should be accepted.
E) None of the projects above should be accepted.

Answer 1

Answer:

B) Project B has below-average risk and an IRR = 8.5 percent.

Explanation:

Since the evaluation is based on IRR, use IRR rule that says you accept a project if its IRR > Cost of capital(WACC in this case)

Project A's IRR of 9% is < 10% WACC for average risk projects hence reject it.

Project B's IRR of 8.5% is > 8% WACC for below- average risk projects hence accept it.

Project C's IRR of 11% is < 12% WACC for above- average risk projects hence reject it.