An all-equity firm is considering the following projects IRR ProjectBeta 61 85 1

Question

An all-equity firm is considering the following projects IRR ProjectBeta 61 85 1.17 1.55 9.1 % 10.5 14.0 17.0 The T-bl rate is 5 percent, and the expected return on the market is 12 percent. a. Compared with the firm's 12 percent cost of capital, Project W has a lower expected expected return, Project Y has a higher return, Project X has a lower expected return, and Project Z has a higher expected return b. Project W should be 4), Project Y should be accepted 4), and Project Z should be accepted , Project X should be accepted accepted c. If the firm's overall cost of capital were used as a hurdle rate, Project W would be (Click to select) (Click to select) , Project X would be (Click to select) , Project Y would be , and Project Z would be (Click to select)

Explanation / Answer

Cost of capital=risk free+beta*(market return-risk free)
W's cost of capital=5%+0.61*(12%-5%)=9.27%
X's cost of capital=5%+0.85*(12%-5%)=10.95%
Y's cost of capital=5%+1.17*(12%-5%)=13.19%
Z's cost of capital=5%+1.55*(12%-5%)=15.85%

hence, W and X are having lower cost of capital than the firm as a whole and Y and Z are having higher cost of capital than the firm as a whole

As Project W is having lower IRR(9.1) than its cost of capital(9.27), it should be rejected
As Project X is having lower IRR(10.95) than its cost of capital(10.95), it should be rejected
As Project Y is having higher IRR(14) than its cost of capital(13.19), it should be accepted
As Project Z is having higher IRR(17) than its cost of capital(15.85), it should be accepted

If the firm's overall cost of capital were used as hurdle rate, all projects having IRR greater than overall cost of capital(12) would be accepted and less than cost of capital(12) would be rejected

hence, W and X would be rejected
Y and Z would be accepted

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