4.) Langston Labs has an overall (composite) WACC of 10%, which reflects the cos

Question

4.) Langston Labs has an overall (composite) WACC of 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Langston evaluates low-risk projects with a WACC of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects:

Expected

Project

Risk

Return

A

High

15%

B

Average

12%

C

High

11%

D

Low

9%

E

Low

6%

Which set of projects would maximize shareholder wealth?

Expected

Project

Risk

Return

A

High

15%

B

Average

12%

C

High

11%

D

Low

9%

E

Low

6%

Which set of projects would maximize shareholder wealth?

Explanation / Answer

The projects' whose return is greater than its WACC, those projects would increase the shareholders' wealth.

So, For High risk projects, only Project A's return (15%) is greater than the WACC(12%) for the high risk projects.

For Average risk projects, there is only one project, i.e., B, its return(12%) is greater than the WACC(10%) for the average risk projects.

For Low risk projects, only Project D's return(9%) is greater than the WACC(8%) for the low risk projects.

Hence, Project A,B and D are the projects that would maximize shareholder wealth.

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