An all-equity firm is considering the following projects: Project Beta IRR W .67 9.5 % X .74 10.6 Y 1.37 14.1 Z 1.48 17.1 The T-bill rate is 5.1 percent, and the expected return on the market is 12.1 percent. a. Compared with the firm's 12.1 percent cost of capital, Project W has a lower expected return, Project X has a lower expected return, Project Y has a higher expected return, and Project Z has a higher expected return. b. Project

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Question:

An all-equity firm is considering the following projects:
Project Beta IRR
W .67 9.5 %
X .74 10.6
Y 1.37 14.1
Z 1.48 17.1
The T-bill rate is 5.1 percent, and the expected return on the market is 12.1 percent.
a. Compared with the firm's 12.1 percent cost of capital, Project W has a lower expected return, Project X has a lower expected return, Project Y has a higher expected return, and Project Z has a higher expected return.
b. Project W should be rejected , Project X should be accepted , Project Y should be rejected , and Project Z should be accepted .

Answers

Answer: Projects W and X have lower expected returns Projects Y and Z have higher expected returns Explanation: Given [tex]\begin{array}{ccc}{Project} & {Beta} & {IRR} & {W} & {.67} & {9.5\%} & {X} & {.74} & {10.6\%} & {Y} & {1.37} & {14.1\%}& {Z} & {1.48} & {17.1\%} \ \end{array}[/tex][tex]T\ Bill\ Rate = 5.1\%[/tex] [tex]Expected\ Return = 12.1\%[/tex] Solving (a): Compare the expected return of each project to 12.1% Expected Return of each project is calculated as: [tex]Project = T\ Bill + (Beta * (Expected\ Return - T\ Bill))[/tex] [tex]Project = 5.1\% + (Beta * (12.1\% - 5.1\%))[/tex] [tex]Project = 5.1\% + (Beta * 7.0\%)[/tex] For Project W: [tex]W= 5.1\% + (0.67* 7.0\%)[/tex] [tex]W= 5.1\% + 4.69\%[/tex] [tex]W= 9.79\%[/tex] Lower Expected return For Project X: [tex]X = 5.1\% + (0.74 * 7.0\%)[/tex] [tex]X = 5.1\% + 5.18\%[/tex] [tex]X = 10.28\%[/tex] Lower Expected return For Project Y: [tex]Y = 5.1\% + (1.37 * 7.0\%)[/tex] [tex]Y = 5.1\% + 9.59\%[/tex] [tex]Y = 14.69\%[/tex] Higher Expected return For Project Z: [tex]Z = 5.1\% + (1.48 * 7.0\%)[/tex] [tex]Z = 5.1\% + 10.36\%[/tex] [tex]Z = 15.46\%[/tex] Higher Expected return There is no question in (b)

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