An all-equity firm is considering the projects shown as follows. The T-bill rate is 4 percent and the market risk premium is 7 percent. If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s), if any, will be incorrectly accepted or rejected? $$\begin{array} { | l | l | l | }
\hline \text { Project } & \text { Expected Return } & \text { Beta } \
\hline \text { A } & 9.0 \% & 0.6 \
\hline \text { B } & 20.0 \% & 1.2 \
\hline \text { C } & 13.0 \% & 1.4 \
\hline \text { D } & 17.0 \% & 1.5 \
\hline
\end{array}$$
A)Project A would be incorrectly rejected.
B)Both Projects A and C would be incorrectly rejected.
C)Project A will be incorrectly rejected and Project B would be incorrectly accepted.
D)None of the projects will be incorrectly accepted or rejected.

Question

An all-equity firm is considering the projects shown as follows. The T-bill rate is 4 percent and the market risk premium is 7 percent. If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s), if any, will be incorrectly accepted or rejected? $$\begin{array} { | l | l | l | } 
\hline \text { Project } & \text { Expected Return } & \text { Beta } \
\hline \text { A } & 9.0 \% & 0.6 \
\hline \text { B } & 20.0 \% & 1.2 \
\hline \text { C } & 13.0 \% & 1.4 \
\hline \text { D } & 17.0 \% & 1.5 \
\hline
\end{array}$$
A)Project A would be incorrectly rejected.
B)Both Projects A and C would be incorrectly rejected.
C)Project A will be incorrectly rejected and Project B would be incorrectly accepted.
D)None of the projects will be incorrectly accepted or rejected.

Quizplus · Accepted Answer

Project A's expected return is less than its required return (8.2%), so it would be incorrectly rejected. Project B's expected return is higher than its required return (12.4%), so it would be correctly accepted. However, using the WACC of 12% for Project B would incorrectly accept it since its required return should be 12.4%.

An All-Equity Firm Is Considering the Projects Shown as Follows