Use the following information to answer the question(s)below.
Nielson Motors has a debt-equity ratio of 1.8,an equity beta of 1.6,and a debt beta of 0.20.It is currently evaluating the following projects,none of which would change Nielson's volatility. (All amounts are in $millions. )
-Which of the following projects should Nielson Motors accept?

Question

Use the following information to answer the question(s)below.
Nielson Motors has a debt-equity ratio of 1.8,an equity beta of 1.6,and a debt beta of 0.20.It is currently evaluating the following projects,none of which would change Nielson's volatility.  (All amounts are in $millions. )
-Which of the following projects should Nielson Motors accept?

Quizplus · Accepted Answer

To determine which project is best, we need to calculate the expected return for each project using the CAPM model:

r(project) = r(free) + [β(equity) * (r(market) - r(free))] + [β(debt) * (r(debt) - r(free))]

Assuming a risk-free rate of 3.5%, a market risk premium of 6.5%, and a cost of debt of 4%, we get the following expected returns:

1. r(1) = 3.5% + [1.6 * 6.5%] + [1.8 * 0.5%] = 16.55%
2. r(2) = 3.5% + [1.4 * 6.5%] + [1.8 * 0.5%] = 15.95%
3. r(3) = 3.5% + [0.8 * 6.5%] + [1.8 * 0.5%] = 9.35%
4. r(4) = 3.5% + [0.8 * 6.5%] + [1.2 * 0.5%] = 8.75%
5. r(5) = 3.5% + [1.0 * 6.5%] + [0.8 * 0.5%] = 11.95%

Based on these expected returns, project 1 has the highest return and should be accepted. Projects 2 and 5 have slightly lower returns but could also be acceptable. Projects 3 and 4 have significantly lower returns and should not be accepted. Therefore, the best choice is C, which includes only projects 1 and 4.

Use the Following Information to Answer the Question(s)below