LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its be

Question

LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?

Project B, which is of below-average risk and has a return of 8.5%.

Project C, which is of above-average risk and has a return of 11%.

Project A, which is of average risk and has a return of 9%.

None of the projects should be accepted.

All of the projects should be accepted.

a)

Project B, which is of below-average risk and has a return of 8.5%.

b)

Project C, which is of above-average risk and has a return of 11%.

c)

Project A, which is of average risk and has a return of 9%.

d)

None of the projects should be accepted.

e)

All of the projects should be accepted.

Explanation / Answer

Every company takes the decision to accept the project with lower risk and higher return or the project with return higher than the cost of capital.

A

Here Project B has the lower risk i.e., below average risk and return (8.5%) is greater than the WACC (8%). Hence Project B should be accepted.

Correct Option is a) Project B, which is of below average risk and has a return of 8.5% should be accepted.

Project WACC Return

A

10% 9% B 8% 8.5% C 12% 11%

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