# Answers to Questions 1 and 2

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```					                                                         Professor Kose John
Spring 2003

Solution to Problems on APV and WACC

(a) a = 1.5, ra = rF + a(rm - rF)
= .07 + 1.5(.04)
= .13

     D
ra  ra 1 - t   .13(1- .5(.3))
*

     V
 0.1105
13
NPV  - 110           7.64  0
.1105
Accept Project.

(b) ra = .07 + 3(.04) = 0.19
ra*  0.19(1 - .5(.3))  0.19(.85)  0.1615

Since the required rate of return (adjusted cost of capital) is less than 18% the project
should be accepted. Its NPV will be positive.

(c) Given the ’s of the projects, the ra and the ra* for each project can be computed, as
in (a) or (b).

Process A

ra = .07 + 1.8(.04) = .142

ra* = .142(1-.5(.3))

= .142(.85) = .1207

Process B

ra = .07 + 3.4 (.04) = .206

ra* = 0.206(1 - .5(.3)) =.1751
18
NPV(A)  - 99           50.13
0.1207
26.4
NPV(B)  - 108          42.77
.1751
Since NPV(A) > NPV(B), accept project A

```
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