An all-equity firm is considering the projects shown as follows.
$$\begin{array} { c c }
\text { Project } & \text { Expected Return } & \text { Beta } \
\text { A } & 9.0 \%&0.7 \
\text { B } & 20.0 \%& 1.1\
\text { C } & 15.0 \%& 1.5\
\text { D } & 18.0 \%&1.9
\end{array}$$
The T-bill rate is 4 percent and the market risk premium is 8 percent. If the firm uses its current WACC of 13 percent to evaluate these projects, which project(s) will be incorrectly accepted?
A) Project A
B) Project C
C) Project D
D) Projects C and D

Question

An all-equity firm is considering the projects shown as follows.
$$\begin{array} { c c } 
\text { Project } & \text { Expected Return } & \text { Beta } \
\text { A } & 9.0 \%&0.7 \
\text { B } & 20.0 \%& 1.1\
\text { C } & 15.0 \%& 1.5\
\text { D } & 18.0 \%&1.9
\end{array}$$
The T-bill rate is 4 percent and the market risk premium is 8 percent. If the firm uses its current WACC of 13 percent to evaluate these projects, which project(s) will be incorrectly accepted?
A) Project A
B) Project C
C) Project D
D) Projects C and D

Quizplus · Accepted Answer

Projects C and D will be incorrectly accepted because their expected returns do not compensate for their risk levels when compared to the Capital Asset Pricing Model (CAPM) formula, which is $r = r_f + \beta(r_m - r_f)$, where $r$ is the expected return, $r_f$ is the risk-free rate, $r_m$ is the expected market return, and $\beta$ is the beta of the project. Using the CAPM formula, the required returns for Projects C and D are higher than their expected returns, making them unattractive investments when evaluated correctly.

An All-Equity Firm Is Considering the Projects Shown as Follows