Problem 3.

Consider a setting where the marginal tax rate is 0, the market risk premium is 5%, and the risk-free rate is 2%. You work for a firm that has a default spread that is equal to 0.05 times its market beta. The firm is considering an investment project that has an expected return on equity that is greater than the firms WACC. The project is small, and its risk is similar to the risk of the firms existing projects. Which of the following is correct:

a.The firm should proceed with the project.

b.The firm should not proceed with the project.

c.We cant answer this question without further information.

Explain your answer