Answer: Reject the project because the ARAROC is lower than the risk-free rate.

The correct answer is C. The explanation for this is based on the adjusted RAROC (Risk-Adjusted Return on Capital) formula, which is used to evaluate a project's viability by considering both the project's risk and return. The formula for ARAROC is: \[ ARAROC = RAROC - \beta_e \times (R_m - R_f) \] Where: - \( RAROC \) is the Risk-Adjusted Return on Capital for the project, which is given as 15%. - \( \beta_e \) is the beta of the equity of the firm, given as 1.8. - \( R_m \) is the expected market rate of return, given as 11% per year. - \( R_f \) is the risk-free rate of interest, given as 3% per year. The term \( \beta_e \times (R_m - R_f) \) represents the risk premium of the project, which accounts for the systematic risk associated with the project's returns. When this risk premium is subtracted from the RAROC, it adjusts the return for the systematic risk, giving us the ARAROC. Plugging in the given values: \[ ARAROC = 0.15 - 1.8 \times (0.11 - 0.03) \] \[ ARAROC = 0.15 - 1.8 \times 0.08 \] \[ ARAROC = 0.15 - 0.144 \] \[ ARAROC = 0.006 \text{ or } 0.6\% \] Since the calculated ARAROC of 0.6% is less than the risk-free rate of 3%, the project does not provide enough return to compensate the shareholders for the non-diversifiable systematic risk they would bear when investing in the project. Therefore, based on the ARAROC criterion, the project should be rejected.

Author: LeetQuiz Editorial Team