Suppose the company is evaluating three projects with the following characteristics
Each project has a cost of $1mil. They will be financed using the target mix of long-term debt, preferred stock, and common equity. The cost of the common equity for each project should be based on the beta estimated for the project. All equity will come from reinvested earnings.
Beta | rs | rps | rd(1-T) | WACC | Expected Return on Project | |
Project A | 0.5 | 9.5% | 11% | 6.5% | 8.23% | 9% |
Project B | 1.0 | 12.5% | 11% | 6.5% | 9.73% | 10% |
Project C | 2.0 | 18.5% | 11% | 6.5% | 12.73% | 11% |
Alanlyze the company's situation and explain why each project should be accepted or rejected.
The question can be simply answered by looking at the WACC and Expected Return on Project.
If WACC< Expected Return: Accept the Project. Else Reject the Project.
Target Mix of debt, preferrence shares and common shares, beta, equity risk premium, all would be required to calculate the WACC. Since, WACC is already given, we do not have to go into those calculatations.
Project A: Accept (8.23<9)
Project B: Accept (9.73<10)
Project C: Reject (12.73>11)
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