PLEASE SHOW WORK 1. MAD Inc. is evaluating the following four independent, inves

Question

PLEASE SHOW WORK

1. MAD Inc. is evaluating the following four independent, investment opportunities:

Project Cost
A $300,000 B 150,000 C 200,000 D 400,000

IRR
14%

10%

13%

11%

MAD’s target capital structure is 60 percent debt and 40 percent equity. The yield to maturity on the company’s new debt will be 10 percent. MAD’s beta is 1.7, the risk free rate is 4% and the required market return is 12%. If the company’s tax rate is 30 percent, then which of the projects will be accepted?

A) Projects A, B, C, and D

B) Projects A, C, and D

C) Project A

D) Projects A and C

Explanation / Answer

WACC = Wd×Rd×(1-t)+We×Ke

W is weights of respective portfolios

R is return on respective portfolios

Wd+We = 1

= 0.60×10%×(1-30%)+0.40×(4%+1.7×(12%-4%))

= 0.60×7%+0.40×17.6%

= 11.24% or 11%

IRR of A, C was higher than WACC and D was equal to IRR.

Hence, correct option is (B)

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