Question

11. Langston Labs has an overall (composite) WACC of 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Langston evaluates low-risk projects with a WACC of 8%, average projects at 10%, and high-risk projects at 12%. The company is considering the following projects:

Project               Risk               Expected Return

A                      High                          15%

B                     Average                     12

C                    High                          11

D                      Low                          9

E                      Low                           6

Which set of projects would maximize shareholder wealth?

Answer 1

To maximize shareholder wealth, the expected return on the project should be greater than the respective WACC for the project. We will evaluate the projects as below-

Project A 12% WACC < 15% Return (select)

Project B 10% WACC < 12% Return (select)

Project C 12% WACC > 11% Return (reject)

Project D 8% WACC < 9% Return (select)

Project E 8% WACC > 6% Return (reject)

Hence, project A, B, and C would maximize shareholder wealth.

Let me know in the comment section in case of any doubt.