EBK CFIN
6th Edition
ISBN: 9781337671743
Author: BESLEY
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 10, Problem 19PROB
Summary Introduction
Project risk should be considered in the capital budgeting decision. When a project is chosen, it is possible that the risk of the project is different from the firm’s average risk. Hence, it is essential to use the risk adjusted discount rate when evaluating a project. A risk adjusted discount rate is one in which he projects’ risk or the premium of taking the risk of that project is adjusted to the firm’s average risk. Average-risk projects are discounted at the average
Firstly, each project is classified in to three categories, high risk, average risk and low risk. Then the average required rate of return of the firm is used as the discount rate for average risk project, reduces the rate of return by 1-3 percent for low risk project and increases the discount rate accordingly for high risk projects. It is important to incorporate project risk in capital budgeting decision, or else one might end up making incorrect decision.
Following are the three independent project which the company needs to evaluate. It usually does so by adjusting its average required rate of return, r of 11%. A high-risk project is adjusted for 4% and a low risk project is adjusted for 2%.
| Project | Risk | |
| P | 10.0% | Low |
| Q | 12.0% | Average |
| R | 14.5% | High |
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How do I determine which is the correct answer for this problem? A company estimates that an average-risk project has a WACC of 10 percent, a below-average-risk project has a WACC of 8 percent, and an above-average-risk project has a WACC of 12 percent. Which of the following independent projects should the company accept? a. Project A has average risk and an IRR = 9 percent. b. Project B has below-average risk and an IRR = 8.5 percent. c. Project C has above-average risk and an IRR = 11 percent. d. All of the projects above should be accepted. e. None of the projects above should be accepted.
Please answer fast I give you upvote.
Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?
A. Without information about the projects' NPVs we cannot determine which project(s) should be accepted.
B. Project C, which has above-average risk and an IRR = 11%.
C. Project A, which has average risk and an IRR = 9%.
D. Project B, which has below-average risk and an IRR = 8.5%.
E. All of these projects should be accepted.
Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?
Project B, which has below-average risk and an IRR = 8.5%.
All of these projects should be accepted as they will produce a positive NPV.
Without information about the projects’ NPVs we cannot determine which one or ones should be accepted.
Project C, which has above-average risk and an IRR = 11%.
Project A, which has average risk and an IRR = 9%.
(I want see step to step to get the answer
Project B, which has below-average risk and an IRR = 8.5%.
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