Louisiana Enterprises, an all-equity firm, is considering a new capital investment. Analysis has indicated that the proposed investment has a beta of 0.5 and will generate an expected return of 7 percent. The firm currently has a required return of 10.75 percent and a beta of 1.25. The investment, if undertaken, will double the firm's total assets. If k(RF) = 7 percent and the market return is 10 percent, should the firm undertake the investment?
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A. B. C. D. E.A
Calculate the required return and compare to the expected return. k(s) = k(RF) + (k(M) - k(RF))b = 0.07 + (0.10 - 0.07)0.5 = 0.085 = 8.5%.
The expected return of the asset (7%) is less than the required return (8.5%) so the investment should not be made.