Question

Explain whether each firm should take the project??

Suppose two financed equity firms (1: Stark industries) and (2: Acme company), are considering the exact new project with a beta of 1. Project IRR is 9.8%. Stark industries beta is 1.2 and ACME company beta is 0.6. The expected market risk pemium is 6% and risk-free rate is 3%.

Answer #1

Stark industries:

Beta=1.2

Project IRR is 9.8%

The expected market risk premium is 6% and risk-free rate is
3%.

Cost of capital=Risk free rate + Beta*(Market risk premium)

Cost of capital=3%+1.2*6%

=0.03+0.072

=0.102 or 10.20%

IRR<Cost of capital, the project should be rejected.

Acme company

Beta=0.6

Project IRR is 9.8%

The expected market risk premium is 6% and risk-free rate is
3%.

Cost of capital=Risk free rate + Beta*(Market risk premium)

Cost of capital=3%+0.6*6%

=0.03+0.036

=0.066 or 6.60%

IRR>Cost of capital, the project should be accepted.

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