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In: Accounting

On-line Text Co. has four new text publishing products that it must decide on publishing to...

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, ßs of 1.6. The risk-free rate is 7% and the market rate is expected to be 12%. The projects are expected to earn as follows:
i. Project W: 14%
ii. Project X: 18%
iii. Project Y: 17%
iv. Project Z: 15%

Justify which projects should be selected and give reason.

Does current WACC rate of 17% is irrelevant or relevant? Justify your answer

Solutions

Expert Solution

Required rate of return = Risk free rate + [beta * (market rate of return - risk free rate)]

Required rate of return = 7% + [1.60 * (12% - 7%)]

Required rate of return = 7% + 8% = 15%

So, required rate of return = 15%

So, select projects whose returns greater than the required rate of return (15%) are to be selected.

Project X (18%), Project Y (17%) projects to be selected, because they provide returns more than what investors expect. and project X and Y provide returns more than the required rate of returns which is 15%..

The net present value of the projects will also be greater than zero (0)

[NPV > 0]

Project Z (15%) , it is indifferent , NPV = 0

Project W (14%), < 15%, Reject the project, NPV also will be less than zero.

Projects Decision
W Reject
X Accept
Y Accept
Z Indifferent

b) WACC rate of 17%is irrelevant. The risk of the projects must be different than risk of company. so WACC is not considered.

ekkarill92 answered 2 years ago
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