Question

A project has a level of systematic risk of 1.25. The expected return on the market portfolio is 12%, and the risk free rate is 5%. If an investment’s internal rate of return is 12%

a.	The project should be accepted
	b.	The project should be rejected because IRR is less than the required rate of return
	c.	The project should be rejected because it is over-priced.
	d.	Both b and c are correct
	e.	Not enough information to tell

Answer 1

Correct answer is option d.Both b and c are correct

Here first we need to calculate the expected return

Expected return on portfolio = Risk free rate + Beta * (Expected market return - Risk free rate)

Beta is nothing but systematic risk

Expected return = 5% + 1.25 * (12% - 5%) = 13.75%

Since the IRR is less than the expected return,project should be rejected.

Since the expected return is morethan the market return,project is seems to be over priced. So both the options b and c are correct.