Laramie Labs uses a risk-adjustment when evaluating projects of different risk.

Question

Laramie Labs uses a risk-adjustment when evaluating projects of different risk. Its firm overall WACC is 10%, but its assets vary widely in risk with an average project having a coefficient of variation (CV) of expected return in t range of 0.8-1.2. Laramie 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. 8. CV 1.40 0.95 1.30 0.70 0.60 Project Expected Return 15% 12% 1196 9% 6% Which set of projects would maximize shareholder wealth? a. A and B b. A, B, and C C. A, B, and D d. A, B, C, and E

Explanation / Answer

we determine the risk from the CV value

hence choose C)

Project Risk Expected Return Required Return (WACC) Accept/Reject Reason A High 15% 12% Accept Expected Return is more than Required Return B Average 12% 10% Accept Expected Return is more than Required Return C High 11% 12% Reject Expected Return is less than Required Return D Low 9% 8% Accept Expected Return is more than Required Return E Low 6% 8% Reject Expected Return is less than Required Return

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