Question

An all-equity firm is considering the following projects:

Answer 1

Answer:

A. Compared with the firm's 12 percent cost of capital, Project W has a_______expected return.

• a. lower

1. Project X has a______expected return.

• b. lower

2. Project Y has a_______expected return

• b. higher

3. Project Z has a______expected return.

• a. higher

B. Project W should be_______.

• b. rejected

1. Project X should be______.

• b. rejected

2. Project Y should be_______.

• a. accepted

3. Project Z should be_______.

• a. accepted

c. If the firm's overall cost of capital were used as a hurdle rate, Project W would be_______.

• c. correctly rejected

1. Project X would be______.

• c. correctly rejected

2. Project Y would be_______.

• b. correctly accepted

3. Project Z would be________.

• b. correctly rejected

Explanation:

Project    Beta     IRR         expected return

W             .62      9.2%       = 5% + (0.62 x 7%) = 9.34%

X              .77      10.3 %     = 5% + (0.77 x 7%) = 10.39%

Y            1.27       14.1 %      = 5% + (1.27 x 7%) = 13.89%

Z            1.42       17.0%     = 5% + (1.42 x 7%) = 14.94%