Table 12.3
Tangshan Mining Company is considering investment in one of two mutually exclusive projects M and N which are described below. Tangshan Mining's overall cost of capital is 15 percent, the market return is 15 percent and the risk-free rate is 5 percent. Tangshan estimates that the beta for project M is 1.20 and the beta for project N is 1.40.
-Which project would be preferable if both projects were of average risk as the overall firm and Tangshan Mining has a beta of 1.0? (See Table 12.3)

Question

Table 12.3
Tangshan Mining Company is considering investment in one of two mutually exclusive projects M and N which are described below. Tangshan Mining's overall cost of capital is 15 percent, the market return is 15 percent and the risk-free rate is 5 percent. Tangshan estimates that the beta for project M is 1.20 and the beta for project N is 1.40. 
-Which project would be preferable if both projects were of average risk as the overall firm and Tangshan Mining has a beta of 1.0? (See Table 12.3)

Quizplus · Accepted Answer

To evaluate the projects, we need to calculate their NPV and IRR based on Tangshan Mining's cost of capital (15%) and their respective betas. Using Table 12.3, we can find the required rates of return for each project: 
- Project M: 20% (15% + 1.20*(15%-5%)) 
- Project N: 22% (15% + 1.40*(15%-5%))

Calculating the NPV for each project using their respective required rates of return, we get: 
- NPV(M) = -$5,991 
- NPV(N) = $2,869

Therefore, project N has a higher NPV and would be preferable under these conditions. The IRRs for each project are not relevant in this comparison.

Table 12.3 Tangshan Mining Company Is Considering Investment in One of Two