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An all-equity firm is considering the following projects:
| Project | Beta | IRR | ||||
| W | .55 | 10.0 | % | |||
| X | .90 | 10.5 | ||||
| Y | 1.10 | 14.0 | ||||
| Z | 1.81 | 17.0 | ||||
The T-bill rate is 5 percent, and the expected return on the market is 12 percent.
a. Compared with the firm’s 12 percent cost of capital, Project W has a (Click to select) lower higher expected return, Project X has a (Click to select) higher lower expected return, Project Y has a (Click to select) higher lower expected return, and Project Z has a (Click to select) lower higher expected return.
b. Project W should be (Click to select) accepted rejected , Project X should be (Click to select) accepted rejected , Project Y should be (Click to select) accepted rejected , and Project Z should be (Click to select) accepted rejected .
c. If the firm’s overall cost of capital were used as a hurdle rate, Project W would be (Click to select) correctly rejected correctly accepted incorrectly accepted incorrectly rejected , Project X would be (Click to select) incorrectly accepted incorrectly rejected correctly rejected correctly accepted , Project Y would be (Click to select) correctly rejected incorrectly rejected incorrectly accepted correctly accepted , and Project Z would be (Click to select) incorrectly rejected correctly accepted correctly rejected incorrectly accepted .
Expert Answer
| a | |||||||||||||||||||||
| Compared with the firm’s 12 percent cost of capital, Project W has a lower expected return, Project X has a lower expected return, Project Y has a higher expected return, and Project Z has a higher expected return | |||||||||||||||||||||
| b | |||||||||||||||||||||
| Project W should be accepted , Project X should be rejected , Project Y should be accepted , and Project Z should be accepted | |||||||||||||||||||||
| c | |||||||||||||||||||||
| If the firm’s overall cost of capital were used as a hurdle rate, Project W would be incorrectly rejected , Project X would be correctly rejected , Project Y would be correctly accepted , and Project Z would be correctly accepted | |||||||||||||||||||||
