CAPM and Hu r dle Rates. A project under consideration has an internal rate of return of 14 percent

QUESTION

CAPM and Hu r dle Rates. A project under consideration has an internal rate of return of 14 percent and a beta of .6. The risk-free rate is 5 percent and the expected rate of return on the market portfolio is 14 percent. a. Should the project be accepted? b. Should the project be accepted if its beta is 1.6? c. Why does your answer change?
a. Risk free rate (Rf) = 5% Beta= 0.6 Market Portfolio= 14% Required rate of return=> Risk free rate (Rf) + Beta* [Market Return (Rm) Risk free rate (Rf)] Or, Required rate of return=> 0.05 + 0.6* (0.14-0.05) = 0.104= 10.4% Yes the project can be accepted. b. If the beta is 1.6, and all other information remains the same, then required rate of return computation would be, Required rate of return=> Risk free rate (Rf) + Beta* [Market Return (Rm) Risk free rate (Rf)] Or, Required rate of return=> 0.05 + 1.6* (0.14-0.05) = 0.194=

% No the project cant be accepted. c. The acceptance of the project was largely dependent on the internal rate of return and on the required rate of return/ cost of capital, now if the IRR> required rate of return then the decision of going ahead with the project would be viable while if the converse scenario occurs it would be better to reject the project.

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