Question

An all-equity firm is considering the projects shown below. The T-bill rate is 6 percent and the market risk premium is 6 percent.

Project		Expected Return				Beta
A			11	%		0.8
B			21	%		1.5
C			15	%		1.7
D			19	%		1.9

Calculate the project-specific benchmarks for each project. (Round your answers to 2 decimal places.)

Project A	%
Project B	%
Project C	%
Project D	%

If the firm uses its current WACC of 14 percent to evaluate these projects, which project, will be incorrectly rejected?

• Project A

• Project B

• Project C

• Project D

Answer 1

Given,

risk free rate Rf = 6%

Market risk premium MRP = 6%

a). required return of the projects based on CAPM is

Ke = Rf + Beta*(MRP)

Project	Expected return	Beta	Required return formula	Required return
A	11%	0.8	6 + 0.8*6	10.8%
B	21%	1.5	6 + 1.5*6	15%
C	15%	1.7	6 + 1.7*6	16.2%
D	19%	1.9	6 + 1.9*6	17.4

Required return calculated is also project specific benchmark as they are calculated using CAPM.

b). If WACC is 14%, project A will be rejected. But based on its beta, required return is 10.8% and project is giving an expected retrun of 11%, which is higher than minimum required return. So this project should not be reject.

So, this project is rejected incorrectly based on WACC.