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 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%


Which set of projects would maximize shareholder wealth?

a.A and B.

b.A, B, and C.

c.A, B, and D.

d.A, B, C, and D.

e.A, B, C, D, and E

Answer 1

Answer:

A, B, and D.

Explanation:

According to the scenario, computation of the given data are as follows:-  

We will have to compare the WACC with the expected return, to find out that which set of project will maximize the shareholder’s wealth.

Particular Risk WACC(required return) (%) Expected Return (%) Select/Reject Reason

Project A High 12 15 Select  WACC is less than expected return.

Project B Average  10 12 Select  WACC is less than expected return.

Project C High  12 11 Reject  WACC is more than expected return.

Project D Low  8 9 Select  WACC is less than expected return.

Project E Low  8 6 Reject  WACC is more than expected return.

     

According to the analysis, option C (project A,B and D) should be selected to maximize shareholder’s wealth.