Problem1. Weatherall Enterprises has no debt or preferred stock it is an all-equity firm and has a beta of 2.0. The chief financial officer is measuring a project with the expected return of a 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being computed is riskier than an average project, in terms of both its beta risk and its total risk. Which of the following statements is right?
a. The project must definitely be rejected since its expected return (before risk adjustment) is less than its required return.
b. Riskier-than-average projects must have their expected returns raised to reflect their higher risk. Clearly, this would make the project acceptable regardless of amount of adjustment.
c. Accept or reject decision depends on the firm's risk-adjustment policy. When Weatherall's policy is to raise the required return on a riskier-than-average project to 3% over rS, then it must reject the project.
d. Capital budgeting projects must be measured solely on the basis of their total risk.
Thus, insufficient information has been offered to make accept or reject decision.
e. The project must definitely be accepted since its expected return (before any risk adjustments) is greater than its required return.