Explanation

To solve this problem, we need to calculate the adjusted RAROC and compare it with the market expected excess return.

Step 1: Calculate the Market Expected Excess Return

• Risk-free rate (Rf) = 3%
• Expected market return (Rm) = 11%
• Market expected excess return = Rm - Rf = 11% - 3% = 8%

Step 2: Calculate the Adjusted RAROC

• Given RAROC = 15%
• Company's equity beta (β) = 1.8
• Adjusted RAROC = (RAROC - Rf) / β
• Adjusted RAROC = (15% - 3%) / 1.8 = 12% / 1.8 = 6.67%

Step 3: Compare and Make Decision

• Adjusted RAROC (6.67%) > Market expected excess return (8%)? NO
• Wait, let me recalculate: 6.67% < 8%

Actually, let me double-check the logic:

Correct Approach: The decision rule for adjusted RAROC is:

• If Adjusted RAROC > Market Excess Return, then Accept the project
• If Adjusted RAROC < Market Excess Return, then Reject the project

Calculations:

• Market Excess Return = Rm - Rf = 11% - 3% = 8%
• Adjusted RAROC = (RAROC - Rf) / β = (15% - 3%) / 1.8 = 12% / 1.8 = 6.67%

Since 6.67% < 8%, the project should be rejected.

But looking at the options:

• Option A says "Reject the project because the adjusted RAROC is higher than the market expected excess return" - This is incorrect reasoning
• Option B says "Accept the project because the adjusted RAROC is higher than the market expected excess return" - This would be correct if it were true
• Option C says "Reject the project because the adjusted RAROC is lower than the risk-free interest rate" - This is incorrect
• Option D says "Accept the project because the adjusted RAROC is lower than the risk-free interest rate" - This is incorrect

Wait, let me recalculate properly:

Actually, I made an error. Let me recalculate:

• Adjusted RAROC = (RAROC - Rf) / β = (15% - 3%) / 1.8 = 12% / 1.8 = 6.67%
• Market Excess Return = Rm - Rf = 11% - 3% = 8%

Since 6.67% < 8%, the project should be rejected.

But none of the options state the correct reason. Let me check if I'm using the right formula.

Actually, the correct adjusted RAROC formula is: Adjusted RAROC = (RAROC - Rf) / β

So: Adjusted RAROC = (15% - 3%) / 1.8 = 12% / 1.8 = 6.67%

And we compare this to the market excess return of 8%.

Since 6.67% < 8%, we should reject the project.

Looking at the options again:

• Option A: "Reject the project because the adjusted RAROC is higher than the market expected excess return" - Wrong reason
• Option B: "Accept the project because the adjusted RAROC is higher than the market expected excess return" - Wrong decision
• Option C: "Reject the project because the adjusted RAROC is lower than the risk-free interest rate" - Wrong reason
• Option D: "Accept the project because the adjusted RAROC is lower than the risk-free interest rate" - Wrong decision

Actually, I think there might be a mistake in my understanding. Let me reconsider:

The correct decision rule is:

• If Adjusted RAROC > Market Excess Return, then Accept
• If Adjusted RAROC < Market Excess Return, then Reject

In this case:

• Adjusted RAROC = 6.67%
• Market Excess Return = 8%
• Since 6.67% < 8%, we should Reject

But the options don't have "Reject because adjusted RAROC is lower than market excess return".

Let me check if I'm calculating correctly: Adjusted RAROC = (RAROC - Rf) / β = (0.15 - 0.03) / 1.8 = 0.12 / 1.8 = 0.0667 = 6.67%

Yes, that's correct.

Looking at the options more carefully: Option A says "Reject the project because the adjusted RAROC is higher than the market expected excess return" - This is incorrect because 6.67% is NOT higher than 8%.

I think the correct answer should be that we REJECT the project, and the correct reasoning is that the adjusted RAROC (6.67%) is LOWER than the market expected excess return (8%).

Since this exact reasoning isn't in the options, but Option A is the only one that suggests rejecting, and it's the closest, though the reasoning is wrong.

Actually, let me double-check the formula: Some sources define Adjusted RAROC differently. Let me verify:

The standard formula is: Adjusted RAROC = (RAROC - Rf) / β

And the decision rule is: If Adjusted RAROC > (Rm - Rf), then accept.

In this case: 6.67% < 8%, so reject.

Given the options available, and since the question asks which correctly describes the decision AND rationale, and only Option A has the correct decision (reject), even though the rationale is incorrect, this might be the intended answer.

However, based on proper financial theory, the correct decision is to reject because adjusted RAROC (6.67%) < market excess return (8%).