Question

You are a manager of a company and need to decide whether to undertake the following project. The project offers a 10% expected rate of return. The project's beta is 0.5, the expected market return is 10% and the risk free rate is 0%. Which is the correct decision?

	A.	Undertake the project because the return of the project is greater than the return offered in the market for the same level of risk
	B.	Dont undertake the project because the return offered in the market for the same level of risk is greater than the return offered by the project
	C.	Undertake the project because the return of the project is lower than the return offered in the market for the same level of risk
	D.	Dont undertake the project because the return offered in the market for the same level of risk is lower than the return offered by the project

Answer 1

Answer - Option A (Undertake the project because the return of the project is greater than the return offered in the market for the same level of risk)

Reason :-

Beta of market (can be looked upon as risk) is always equal to 1. Hence after bearing Beta (Risk) of 1 in the market we are earning a return of 10% from the market. But in this project we are earning a return of 10% by just bearing Beta (Risk) of 0.5 which is half the Beta/Risk of the market. i.e, just double return by taking same risk in the market. Therefore, we can say that this project is earning greater return than offered in the market for the same level of risk (means if the Risk/Beta of this project was 1 then this project would have fetched a return of 20% which is greater than the market return with the same level of risk).