An all-equity firm is considering the projects shown below. 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 below. 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 if the firm uses its current WACC of 13 percent to evaluate these projects. This is because their required rate of return is higher than the WACC. The required rate of return for Project C is 15 percent and for Project D is 14 percent, while the WACC is 13 percent. This means that these projects are not generating returns above their cost of capital and are not adding value to the firm. On the other hand, Project A with a required rate of return of 12 percent and Project B with a required rate of return of 11 percent will be correctly accepted.

An All-Equity Firm Is Considering the Projects Shown Below