Question

As a corporate manager, you have been given an investment budget of $24 million. You must choose from among the following three independent projects:

Project	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
A	-$12	$10	$10	$14
B	-$12	$8	$8	$8	$8	$2
C	-$12	$6	$6	$6	$6	$6

(All dollar amounts are in millions.)

The appropriate hurdle rate for all three projects is 12% per year. Given your investment budget of $24 million, which projects will you undertake, if any?

A only

B only

C only

A and B only

A and C only

B and C only

none of the projects

Consider projects Apha and Beta:

Cash Flows ($)
Project	Year 0	Year 1	Year 2	IRR (%)
Alpha	-200,000	+120,500	+146,500	20.86
Beta	-100,000	+65,500	+86,000	31

The hurdle rate (i.e., opportunity cost of capital) is 8.00%. Suppose that you can undertake Alpha or Beta, but not both. Which, if any, project should be undertaken?

Alpha

Beta

Neither project

Sandpiper Inc. is estimating its weighted average cost of capital (WACC). Sandpiper’s capital structure weights on debt, preferred stock, and equity are 40%, 0%, and 60%, respectively. Its corporate tax rate is 30%. The expected returns required by holders of debt and equity are 6.00% and 10.50%, respectively. Compute Sandpiper’s WACC.

6.55%

7.98%

8.11%

8.25%

9.75%

10.00%

The beta and standard deviation of AAA Corp., BBB Corp., and CCC Corp. common stock are given in the following table:

Stock	Beta	Standard Deviation
AAA Corp.	0.43	52%
BBB Corp.	0.82	81%
CCC Corp.	1.24	35%

Which stock is the riskiest to a diversified investor who spreads her portfolio equally across 100 stocks from different industries?

AAA Corp.

BBB Corp.

CCC Corp.

Which stock is the riskiest to an undiversified investor who puts all her funds in one of these stocks?

AAA Corp.

BBB Corp.

CCC Corp.

Answer 1

1. use NPV function to find the NPV's of three projects

=NPV(rate, Year1 to Year5 cashflows)-Year0 cashflow

For example, NPV of Project A=NPV(12%,Year1 to Year3 cashflows)-12=$14.9 million

Project A and B has higher NPV's. Hence both of them have to be selected.

hurdele rate	12%
	Project A	Project B	Project C
Year0	-12	-12	-12
Year1	10	8	6
Year2	10	8	6
Year3	14	8	6
Year4		8	6
Year5		2	6
NPV	14.9	13.4	9.6

2. Which ever project has IRR greater than hurdle rate has to be selected. Here both the projects have higher IRR than 8%. But here we have to select only one, then Beta project has to be selected beacuse of higher IRR than alpha.

3.  WACC=(weight of equity*cost of equity)+(weight of debt*after tax cost of debt)

after tax cost of debt=expected return on debt*(1-tax rate)=6%*(1-30%)=4.2%

WACC=(40%*4.2%)+(60%*10.50%)=7.98%

option b is correct

4. a. Beta is the risk measurement for a diversified investor. Beta=1 is the market portfolio's risk. Beta of higher than 1 is risker than the market portfolio.

CCC Corp has beta higher 1. hence, it is more risker

b. Standard deviation is the measurement of risk for a undiversified investor. Here BBB corp has higher standard deviation, hence the riskiest.