Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?
A) Project A, which has average risk and an IRR = 9%.
B) Project B, which has below-average risk and an IRR = 8.5%.
C) Project C, which has above-average risk and an IRR = 11%.
D) Without information about the projects' NPVs we cannot determine which one or ones should be accepted.
E) All of these projects should be accepted.

Question

Quizplus · Accepted Answer

Since Tapley Inc. uses the NPV method when choosing projects, we cannot determine the best project without information about the projects' NPVs. However, we can determine which project satisfies the WACC requirement for its risk level. Project A has an IRR of 9%, which is lower than the WACC of 10% for average-risk projects, so it should not be accepted. Project C has an IRR of 11%, which is higher than the WACC of 12% for above-average risk projects, but we cannot determine if it is acceptable without the NPV. Project B has a below-average risk and an IRR of 8.5%, which is higher than the WACC of 8% for below-average risk projects, so it should be accepted. Therefore, the best choice is B.