The management of Iron Limited, an all-equity financed company, is considering thefollowing projects:ProjectBlueRedBeta of Project0.61.1IRR8.5%11.0%Assume that the market risk premium is 8% and it is 5% above the risk-free rate. TheCEO of Iron Limited made the following comments:If we have sufficient funds, I will invest in both projects because the IRRs of bothprojects are higher than the market risk premium of 8%. However, if only one projectcan be chosen, we should select Project Red because IRR is higher when compared toProject Blue.'Judge the validity of the CEO's comments. You are required to show relevantcomputations. Your answer should not exceed 200 words.

Approach to solving the question: Step 1: Understand the Role of Beta in Project Evaluation Beta…

Answered: The management of Iron Limited, an…

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter12: Capital Budgeting: Decision Criteria

Section: Chapter Questions

Problem 13P

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Wolff Enterprises must consider one investment project using the capital asset pricing model (CAPM). Relevant information is presented in the following table. Item Rate of return Beta, b Risk-free asset 9% 0.00 Market portfolio 14% 1.00 Project 1.74 a. Calculate the required rate of return for the project, given its level of nondiversifiable risk. b. Calculate the risk premium for the project, given its level of nondiverisifiable risk.
Wolff Enterprises must consider one investment project using the capital asset pricing model (CAPM). Relevant information is presented in the following table. Item Rate of Return Beta, b Risk free asset 8% 0.00 Market Portfolio 13% 1.00 Project 1.12 The required rate of return for the project is? THe risk premium for the price is?
An all-equity firm is considering the projects shown below. The T-bill rate is 4 percent and the market risk premium is 7 percent. Project Expected Return A Project A Project B Project C Project D 8.0% 19.0 13.0 17.0 Calculate the project-specific benchmarks for each project. (Round your answers to 1 decimal place.) O Project C O Project D Beta 0.5 1.2 1.4 % % % % If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s), will be incorrectly accepted? O Project A O Project B
Company X has two mutually exclusive projects. Project 1 has an IRR of 5% and a Beta equal to 1/2. Project 2 has an IRR of 20% and Beta equal to 2. Assume that the risk-free rate is zero, the market risk premium is 10%, the projects are 100%equity financed and the CAPM holds. Then, A. Project 1 is better than project 2 B. Project 2 is better than project 1 C. The company should be indifferent between the two projects D. If the company’s Beta is less than 2, then project 2 is preferable
Cummings Products is considering two mutually exclusive investments whose expected net cash flows are as follows: Construct NPV profiles for Projects A and B. What is each project’s IRR? If each project’s cost of capital were 10%, which project, if either, should be selected? If the cost of capital were 17%, what would be the proper choice? What is each project’s MIRR at the cost of capital of 10%? At 17%? (Hint: Consider Period 7 as the end of Project B’s life.) What is the crossover rate, and what is its significance?
Wolff Enterprises must consider several investment projects, A through E, using the capital asset pricing model (CAPM) and its graphical representation, the security market line (SML). Relevant information is presented in the following table ITEM RATE OF RETURN BETA Risk-free asset 9% 0.0 Market portfolio 14% 1.0 Project A - 1.5 Project B - 0.75 Project C - 2.00 Project D - 0.0 Project E - -0.50 Calculate (1) the required rate of return and (2) the risk premium for each project, given its level of nondiversifiable risk. Use your findings in part a to draw the security market line (required rate of return relative to nondiversifiable risk) Discuss the relative nondiversifiable risk of projects A through E. Assume that recent economic events have caused investors to become less risk-averse, causing the market return to decline to 12%. Calculate the new required returns fcor assets A through E and draw the new security market line on the same graph you drew for b. Compare your findings…
An all-equity firm is considering the projects shown below. The T-bill rate is 4 percent and the market risk premium is 7 percent. If the firm uses its current WACC of 12 percent to evaluate the projects, which project(s), if any, will be incorrectly accepted? Expected Return Beta Project A 8.0% 0.5 Project B 19.0% 1.2 Project C 13.0% 1.4 Project D 17.0% 1.6
Country Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firm’s cost of capital, r, is 10%, and the risk-free rate, RF, is 2%. The firm has estimated each project’s cash flow and each project’s beta, as shown in the following table. Project (j) E F G Initial investment (CF0) -$15,000 -$11,000 -$19,000 Year (t) Cash inflows (CFt) 1 $6,000 $6,000 $ 4,000 2 6,000 4,000 6,000 3 6,000 5,000 8,000 4 6,000 2,000 12,000 Beta 1.80 1.00 0.60 a. Find the NPV of each project, using the firm’s cost of capital. Which project is preferred in this situation? b. The firm uses the following equation to determine the risk-adjusted discount rate, RADRj, for each project j: RADRj = RF + Bj x (rm -RF) Where RF = risk-free rate 2% Bj = beta of project j RADRj = risk-adjusted discount rate for project j rm = expected return on market portfolio 10% Substitute each project’s beta into this equation to determine its RADR. c. Use the RADR for each project to…
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 11 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow -1,040 140 460 660 660 260 660 Use the NPV decision rule to evaluate this project; should it be accepted or rejected?
Data table (Click on the following icon in order to copy its contents into a spreadsheet.) Cash Flow Today ($ millions) Project A -6 B с 2 25 L Cash Flow in One Year ($ millions) 22 5 - 8 <
Consider the case of another company. Kim Printing is evaluating two mutually exclusive projects. They both require a $1 million investment today and have expected NPVS of $200,000. Management conducted a full risk analysis of these two projects, and the results are shown below. Risk Measure Standard deviation of project's expected NPVS Project beta Correlation coefficient of project cash flows (relative to the firm's existing projects) Which of the following statements about these projects' risk is correct? Check all that apply. Project B has more stand-alone risk than Project A. Project A has more corporate risk than Project B. Project A $80,000 1.2 0.7 Project B has more corporate risk than Project A. Project A has more market risk than Project B. Project B $40,000 1.0 0.9
Risk-adjusted rates of return using CAPM Centennial Catering, Inc., is considering two mutually exclusive investments. The company wishes to use a CAPM-type risk-adjusted discount rate (RADR) in its analysis. Centennial's managers believe that the appropriate market rate of return is 12.2%, and they observe that the current risk-free rate of return is 7.4%. Cash flows associated with the two projects are shown in the following table. (Click on the icon here in order to copy the contents of the data table below into a spreadsheet) Initial investment (CFO) Year (f) 1 234 Project X $67,000 Project Y $84,000 Cash inflows (CF) $30,000 30,000 30,000 30,000 $26,000 32,000 42,000 48,000 a. Use a risk-adjusted discount rate approach to calculate the net present value of each project, given that project X has an RADR factor of 1.19 and project Y has an RADR factor of 1.39. The RADR factors are similar to project betas. (Hint: Use the following equation to calculate the required project return…

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