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1 September, 17:35

On-line Text Co. has four new text publishing products that it must decide on publishing to expand its services. The firm's WACC has been 17%. The projects are of equal risk, Beta of 1.6. The risk-free rate is 7% and the market rate is expected to be 12%. The projects expected returns are as follows:

Project W = 14%

Project X = 18%

Project Y = 17%

Project Z = 15%

What project (s) should be clearly rejected?

D. Reject Z

B. Reject Y and Z

A. Reject X and Y

C. Reject W

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Answers (1)
  1. 1 September, 18:18
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    C. Reject W

    Explanation:

    In this question, we apply the Capital Asset Pricing Model (CAPM) which is shown below:

    Expected return = Risk-free rate of return + Beta * (Market rate - Risk-free rate of return)

    = 7% + 1.6 * (12%-7%)

    = 7% + 1.6 * 5%

    = 7% + 8%

    = 15%

    The Project W should be rejected as it gives only 14% expected return which is less than the derived expected return.
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