CFIN -STUDENT EDITION-ACCESS >CUSTOM<
6th Edition
ISBN: 9780357752951
Author: BESLEY
Publisher: CENGAGE C
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Chapter 10, Problem 19PROB
Summary Introduction
Project risk should be considered in the capital budgeting decision. When a project is chosen, it is possible that the risk of the project is different from the firm’s average risk. Hence, it is essential to use the risk adjusted discount rate when evaluating a project. A risk adjusted discount rate is one in which he projects’ risk or the premium of taking the risk of that project is adjusted to the firm’s average risk. Average-risk projects are discounted at the average
Firstly, each project is classified in to three categories, high risk, average risk and low risk. Then the average required rate of return of the firm is used as the discount rate for average risk project, reduces the rate of return by 1-3 percent for low risk project and increases the discount rate accordingly for high risk projects. It is important to incorporate project risk in capital budgeting decision, or else one might end up making incorrect decision.
Following are the three independent project which the company needs to evaluate. It usually does so by adjusting its average required rate of return, r of 11%. A high-risk project is adjusted for 4% and a low risk project is adjusted for 2%.
| Project | Risk | |
| P | 10.0% | Low |
| Q | 12.0% | Average |
| R | 14.5% | High |
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How do I determine which is the correct answer for this problem? A company estimates that an average-risk project has a WACC of 10 percent, a below-average-risk project has a WACC of 8 percent, and an above-average-risk project has a WACC of 12 percent. Which of the following independent projects should the company accept? a. Project A has average risk and an IRR = 9 percent. b. Project B has below-average risk and an IRR = 8.5 percent. c. Project C has above-average risk and an IRR = 11 percent. d. All of the projects above should be accepted. e. None of the projects above should be accepted.
Please answer fast I give you upvote.
Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?
A. Without information about the projects' NPVs we cannot determine which project(s) should be accepted.
B. Project C, which has above-average risk and an IRR = 11%.
C. Project A, which has average risk and an IRR = 9%.
D. Project B, which has below-average risk and an IRR = 8.5%.
E. All of these projects should be accepted.
Clear Contacts is evaluating the following Independernt projects
Project
IRR
Risk
CD
15.0%
High
Average
Low
GH
13.0
RS
10.5
Clear's policy is to adjust its average required rate of returm, which equals 12 percent, when the risk associeted with a project is determined to be either higher-than-
average or lower-than-average. The adjustment for higher-than-average risk projects is 4 percent and the ad ustment for lower-than-average nsk projects is 2 percent
Which projectis) should Ciear purchase?
O Projects CD and CH shouid be pchased, because they both have RRs greater than 12 percen.
O Pojects GH and RS should be purchased
O Only Preject Co should be purchased, becase has the highest RR
O None of the perojects should be perchased.
O Only Project RS should be purchased.
Greater Good Glass (GGG) plans to issue a new bond with a coupon rate of interest equal to the yield to matunity (YTM) on its existing bond. The existing bond, which
was issued five years ago, has a coupon rate of…
Chapter 10 Solutions
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- Suppose the net present values of projects A and B show a distribution as follows. Net Present Value (TL) 750 1000 1250 1500 1750 Project A 0.1 0.15 0.2 0.25 0.3 Project B 0.15 0.25 0.3 0.1 0.2 a) Compare the projects according to the expected value criteria? b) Compare the projects by standard deviation criteria? c) Evaluate A and B projects according to the coefficient of variation criteria?arrow_forwardA firm which uses its WACC for average-risk projects adds and subtracts 3 percentage points for above-average and below-average risk projects, respectively. If its WACC is 8%, which of the following projects should be accepted and why? Project 1: E(r)= 9%; Riskiness: Average; Project 2: E(r)= 9% ; Riskiness: Above Average; Project 3: E(r)= 11%; Riskiness: Average; Project 4: E(r)= 5%; Riskiness: Below Average; Project 5: E(r)= 8%; Riskiness: Below Average; Project 6: E(r)= 10%; Riskiness: Above Average; O A. Project 3 O B. Project 1 OC. Project 5 O D. Project 6arrow_forwardpoints) possible S Carter Company is considering three investment opportunities with the following accounting rates of return: Project X Project Y Project Z ARR 13.25% 6.58% 10,47% Use the decision rule for ARR to rank the projects from most desirable to least desirable. Carter Company's required rate of return is 8%. (1 = most desriable and 3 = least desirable. Select whether each should be accepted or rejected.) Project Rank Accept/Reject 4 deler "k I % 1 2 3 4 5 6 QWERT A trl Project X Project Y Project Z caps lock shift t fn اب 2 @ Z # S $ alt الالالا C V G & Y B hp 7 H N 8 144 ( 9 ا۔ K M U O O P > ie alt ? 7 4 J backspace pause ctri <arrow_forward
- A financial analyst is evaluating the following projects, which are mutually exclusive, meaning that only one of them can be chosen. Based on financial theory and the NPV criterion, which one of these projects should be chosen over the other three? Time A C D -26,000 -7,200 -14,500 -19,600 8,100 11,900 8,100 2,360 8.600 1,150 10,000 2,120 5,700 800 11,100 11,00O0 4,200 850 1,130 9,800 12,480 9,700 830 11,600 Discount 13.9% 13.9% 13.9% 13.9% Rate O Project A O Project B O Project C O Project D O12 345arrow_forwardNPV & IRR Refer to the scenario above. The project(s) you select may vary depending on the WACC and whether the projects are independent or mutually exclusive. Which statement is INCORRECT? If the projects are independent and the WACC is 11.0%, both projects A and B are acceptable. If the projects are independent, Project A would be acceptable if the WACC is 17%, but Project B would not. If a project's NPV is negative, the project cannot be accepted. If the projects are mutually exclusive and the WACC is 11.0%, only project B is acceptable. If the projects are mutually exclusive and the WACC is 6.0%, only project B is acceptable.arrow_forwardQUESTION 5 Invest in any or all of the four projects whose relevant cash flows are given in the following table. The firm has RM7,000,000 budgeted to fund these projects, all of which are known to be acceptable. Initial investment for each project is the same for all projects which is RM1,600,000. The rate of return for all projects is equivalent to 8%. Operating cash outflow Project X Year 1 Project Y Cash Outflow RM1,600,000 (for each project) Operating Cash Inflows RM 440,000 RM 140,000 1 340,000 220,000 (110,000) ( 95,000 ) 105,000 220,000 388,000 180,000 250,000 260,000 370,000 460,000 3. 4. 5. 6. 7. 8. 9. Use this table for PROJECT X and Y Period PVIF 8% 1 0.9259 2 0.8573 3 0.7938 4 0.7350 0.6806 6 0.6302 7 0.5835 8 0.5403 9 0.5002 10 0.4632 8arrow_forward
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