Explanation:
Under this framework, the Adjusted RAROC (ARAROC) is determined by subtracting the systematic risk premium of the project from the RAROC. ARAROC = RAROC - β × (Rm - Rf) Given: RAROC = 12%, β = 1.2, Rf = 3%, Rm = 10% ARAROC = 12% - 1.2 × (10% - 3%) = 12% - 8.4% = 3.6%
The decision rule dictates that a project adds value and should be accepted if the ARAROC is strictly greater than the risk-free rate (Rf). Since ARAROC (3.6%) > Rf (3.0%), the company should accept the project.
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Q.52 An ecommerce entrepreneur is considering a new project with an estimated risk-adjusted return capital (RAROC) of 12%. His multi-million company has an equity beta of 1.2, and the return on risk-free U.S Treasury bills stands at 3%. The expected market rate of return is 10% per annum. Using the criterion of adjusted risk-adjusted return on capital (ARAROC), the company should:
A
Accept the project because the ARAROC is lower than the market expected excess return
B
Reject the project because the ARAROC is lower than the market expected excess return
C
Accept the project because the ARAROC is higher than the risk-free rate of return
D
Reject the project because the ARAROC is higher than the market expected excess return
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