Answer: Accept the project because the adjusted RAROC is higher than the market expected excess return.

## 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%)**.