Question

Beta    IRR

Project 1        0.3      3%

Project 2        0.6      7%

Project 3        0.8      11%

The expected return on the market is 10%.

The risk-free rate is 2%.

The weighted average cost of capital is 8% for all 3 projects.

Which project will be incorrectly rejected?

Answer 1

Expected return of project 1= risk free rate + beta (market return - risk free rate)

= 3% + 0.3 (10% - 2%)

= 2% + 0.3 (8%)

= 2% + 2.4%

= 4.4%

As the expected return and IRR, both are less than WACC, the project is rightly rejected

Expected return of project 2= risk free rate + beta (market return - risk free rate)

= 2% + 0.6 (10% - 2%)

= 2% + 0.6 ( 8%)

= 2% + 4.8%

= 6.8%

As the expected return and IRR both are less than WACC , the project is rightly rejected.

Expected return of project 3= Risk free rate + beta (market return - risk free rate)

= 2% + 0.8 ( 10% - 2%)

= 2% + 0.8 (8%)

= 2% + 6.4%

= 8.4%

As the expected return and IRR are more than WACC , the project 3 will be rightly accepted.

Therefore none of the projects are incorrectly rejected