Question

In: Finance

A project under consideration has an internal rate of return of 13% and a beta of...

A project under consideration has an internal rate of return of 13% and a beta of 0.8. The risk-free rate is 3%, and the expected rate of return on the market portfolio is 13%.


a. What is the required rate of return on the project? (Do not round intermediate calculations. Enter your answer as a whole percent.)

b. Should the project be accepted?

c. What is the required rate of return on the project if its beta is 1.80? (Do not round intermediate calculations. Enter your answer as a whole percent.)

d. If project's beta is 1.80, should the project be accepted?

A ) Required rate of return__________%

B) Accept the Project = Yes or No

C) Required rate of return __________%

D) Accept the project = Yes or No

Solutions

Expert Solution

Given:

Internal rate of return of Project (IRR) = 13%
Beta = 0.8
Risk-free rate = 3%
Expected rate of return on the market portfolio = 13%.

a) Required rate of return on the project when its beta is 0.80

Required return = Risk-free rate + Beta * (Expected rate of return on market - Risk-free rate)

Required return = 3% + 0.8 (13% - 3%)

Required return = 3% + 0.8 * 10%

Required return = 3% + 8% = 11%

Required return = 11%

b) Should the project be accepted?

Required return = 11%
Internal rate of return of Project (IRR) = 13%

Decision: Accept the project. IRR is the rate of growth expected to be generated by the project under consideration. Since IRR > Required rate of return, we should accept the project

c) Required rate of return on the project if its beta is 1.80

Required return = Risk-free rate + Beta * (Expected rate of return on market - Risk-free rate)

Required return = 3% + 1.8 (13% - 3%)

Required return = 3% + 1.8 * 10%

Required return = 3% + 18% = 21%

Required return = 21%

d) Should the project be accepted if its beta is 1.80?

Required return = 21%
Internal rate of return of Project (IRR) = 13%

Decision: Reject the project. As the Beta increases it indicates that the project is risky and therefore the required rate of return also rises.Since IRR < Required rate of return the project is no more an attractive option. So, we should reject the project.


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