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Answer on Economics of Enterprise Question for LaMarcus Streeter

Question #6214
2. LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?

a. Project B, which is of below-average risk and has a return of 8.5%.
b. Project C, which is of above-average risk and has a return of 11%.
c. Project A, which is of average risk and has a return of 9%.
d. None of the projects should be accepted.
e. All of the projects should be accepted.
Expert's answer

Answer

Answer is A. When selecting from several different projects with Internal rate of return (IRR), selected project is with a maximum value of IRR of the same class. Thus Project B is the only one that has a return of 8.5% that is greater than projects of the same risk class.

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