Norris Enterprises, an all-equity firm, has a beta of 2.0. The chief financial o

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Norris Enterprises, an all-equity firm, has a beta of 2.0. The chief financial officer is evaluating a project with an expected return of 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated is riskier than the firm's average project, in terms of both its beta risk and its total risk. Which of the following statements is CORRECT? a. Riskier-than-average projects should have their expected returns increased to reflect their higher risk. Clearly, this would make the project acceptable regardless of the amount of the adjustment. b. The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return. c. The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return. d. The accept/reject decision depends on the firm's risk-adjustment policy. If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rS, then it should reject the project. e. Capital budgeting projects should be evaluated solely on the basis of their total risk. Thus, insufficient information has been provided to make the accept/reject decision. Hide FeedbackShow All Feedback Check My Work Feedback Post Submission Feedback Solution

Norris Enterprises, an all-equity firm, has a beta of 2.0. The chief financial officer is evaluating a project with an expected return of 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated is riskier than the firm's average project, in terms of both its beta risk and its total risk. Which of the following statements is CORRECT? Hide FeedbackShow All Feedback Check My Work Feedback Post Submission Feedback Solution Hide FeedbackShow All Feedback Hide FeedbackShow All Feedback Check My Work Feedback Post Submission Feedback Solution Check My Work Feedback Post Submission Feedback Solution Check My Work Feedback Check My Work Feedback Check My Work Feedback Post Submission Feedback Post Submission Feedback Post Submission Feedback Solution Solution Solution

a. Riskier-than-average projects should have their expected returns increased to reflect their higher risk. Clearly, this would make the project acceptable regardless of the amount of the adjustment. b. The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return. c. The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return. d. The accept/reject decision depends on the firm's risk-adjustment policy. If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rS, then it should reject the project. e. Capital budgeting projects should be evaluated solely on the basis of their total risk. Thus, insufficient information has been provided to make the accept/reject decision.

Explanation / Answer

D . IS CORRECT

The accept/reject decision depends on the firm's risk-adjustment policy. If Norris' policy is to increase the required return on a riskier-than-average project to 3% over rS, then it should reject the project.

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