Chapter 13, Problem 13QAP

a

Summary Introduction

Adequate information:

Beta of Project W $\left({\text{β}}_{\text{W}}\right)$ = 0.75

Beta of Project X $\left({\text{β}}_{\text{X}}\right)$ = 0.90

Beta of Project Y $\left({\text{β}}_{\text{Y}}\right)$ = 1.15

Beta of Project Z $\left({\text{β}}_{\text{Z}}\right)$ = 1.45

IRR of Project W $\left({\text{IRR}}_{\text{W}}\right)$ = 9.4%

IRR of Project X $\left({\text{IRR}}_{\text{X}}\right)$ = 11.2%

IRR of Project Y $\left({\text{IRR}}_{\text{Y}}\right)$ = 14.1%

IRR of Project Z $\left({\text{IRR}}_{\text{Z}}\right)$ = 15.5%

T-bill rate $\left({\text{R}}_{\text{f}}\right)$ = 3.5%

Expected return on market $\left({\text{R}}_{\text{M}}\right)$ = 12%

Firm’s cost of capital $\left(\text{K}\right)$ = 12%

To compute: Projects that have higher expected return than the cost of capital

Introduction: The Cost of capital refers to the minimum return required by a company to justify the value incurred on the project.

b

Summary Introduction

Adequate information:

Beta of Project W $\left({\text{β}}_{\text{W}}\right)$ = 0.75

Beta of Project X $\left({\text{β}}_{\text{X}}\right)$ = 0.90

Beta of Project Y $\left({\text{β}}_{\text{Y}}\right)$ = 1.15

Beta of Project Z $\left({\text{β}}_{\text{Z}}\right)$ = 1.45

IRR of Project W $\left({\text{IRR}}_{\text{W}}\right)$ = 9.4%

IRR of Project X $\left({\text{IRR}}_{\text{X}}\right)$ = 11.2%

IRR of Project Y $\left({\text{IRR}}_{\text{Y}}\right)$ = 14.1%

IRR of Project Z $\left({\text{IRR}}_{\text{Z}}\right)$ = 15.5%

T-bill rate $\left({\text{R}}_{\text{f}}\right)$ = 3.5%

Expected return on market $\left({\text{R}}_{\text{M}}\right)$ = 12%

Firm’s cost of capital $\left(\text{K}\right)$ = 12%

To compute: Which projects should be accepted

Introduction: The project which has internal rate of return (IRR) greater than the expected return (ER) must be accepted, otherwise, it must be rejected.

c

Summary Introduction

Adequate information:

Beta of Project W $\left({\text{β}}_{\text{W}}\right)$ = 0.75

Beta of Project X $\left({\text{β}}_{\text{X}}\right)$ = 0.90

Beta of Project Y $\left({\text{β}}_{\text{Y}}\right)$ = 1.15

Beta of Project Z $\left({\text{β}}_{\text{Z}}\right)$ = 1.45

IRR of Project W $\left({\text{IRR}}_{\text{W}}\right)$ = 9.4%

IRR of Project X $\left({\text{IRR}}_{\text{X}}\right)$ = 11.2%

IRR of Project Y $\left({\text{IRR}}_{\text{Y}}\right)$ = 14.1%

IRR of Project Z $\left({\text{IRR}}_{\text{Z}}\right)$ = 15.5%

T-bill rate $\left({\text{R}}_{\text{f}}\right)$ = 3.5%

Expected return on market $\left({\text{R}}_{\text{M}}\right)$ = 12%

Firm’s cost of capital $\left(\text{K}\right)$ = 12%

To compute: Which projects would be incorrectly accepted or rejected

Introduction: Hurdle rate or cost of capital is the minimum return that is required on the project.