Security Market Line Concept in Capital Budgeting: CFA® Level 1 Exam

The Security Market Line Concept in Capital Budgeting

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Question

Using the Security Market Line concept in capital budgeting, which of the following is correct?

Answers

A. If two mutually exclusive projects' expected returns are both above the SML, the project with the lower risk should be accepted.

B. If a project's expected rate of return is greater than the expected rate of return on an average project, it should be accepted.

C. If a project's return lies below the SML, it should be rejected if it has a beta greater than the firm's existing beta but accepted if its beta is below the firm's beta.

D. If the expected rate of return on a given capital project lies above the SML, the project should be accepted even if its beta is above the beta of the firm's average project. D

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Explanations

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A. B. C. D.

Explanation

If the expected rate of return on a given capital project lies above the SML, the expected rate of return on the project is more than enough to compensate for its risk, and the project should be accepted. Conversely, if the project's rate of return lies below the SML, it should be rejected.

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