Suppose that two ﬁrms, A and B, are considering the same project which has the same risk as ﬁrm B's overall operations. The project has an IRR of 14.0%. Firm A has a beta of 1.4, while ﬁrm B's beta is
1)1. If the risk-free rate is 5.25% and the market risk premium is 7.0%, which ﬁrm(s) should take the
Project?

Question

Quizplus · Accepted Answer

To determine whether a project is worth investing in, we need to compare the project's expected return (IRR) with the required return for the project, which is the risk-free rate plus a premium based on the project's risk as measured by beta.

For Firm A: 
Required return = 5.25% + 1.4(7.0%) = 14.05%
IRP < Required return, so Firm A should not take the project.

For Firm B: 
Required return = 5.25% + 1(7.0%) = 12.25%
IRP> Required return, so Firm B should take the project.

Since the project has the same risk as Firm B's overall operations, both Firm A and Firm B should have the same beta of 1. Therefore, we can conclude that Firm B is the only one that should take the project. Thus, the answer is choice letter B only.

Suppose That Two ﬁRms, a and B, Are Considering the Same