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Karsted Air Services is now in the final year of a project. The equipment originally cost...

Karsted Air Services is now in the final year of a project. The equipment originally cost $35 million, of which 90% has been depreciated. Karsted can sell the used equipment today for $8.75 million, and its tax rate is 30%. What is the equipment's after-tax salvage value? Round your answer to the nearest dollar. Write out your answer completely. For example, 13 million should be entered as 13,000,000. Marble Construction estimates that its WACC is 10% if equity comes from retained earnings. However, if the company issues new stock to raise new equity, it estimates that its WACC will rise to 10.8%. The company believes that it will exhaust its retained earnings at $2,500,000 of capital due to the number of highly profitable projects available to the firm and its limited earnings. The company is considering the following seven investment projects: Project Size IRR A $650,000 14.0% B 1,050,000 13.5 C 1,000,000 11.2 D 1,200,000 11.0 E 500,000 10.7 F 650,000 10.3 G 700,000 10.2 Assume that each of these projects is independent and that each is just as risky as the firm's existing assets. Which set of projects should be accepted? Project A Project B Project C Project D Project E Project F Project G What is the firm's optimal capital budget? Write out your answer completely. For example, 13 million should be entered as 13,000,000. $

Solutions

Expert Solution

(i) Post tax salvage value =
Consideration = 8750000
Less: Carrying value of equipment (cost x (1-90%)) = 3500000
Gain = 5250000
Tax on above gain 5250000*30% 1575000
Post tax salvage value = Sale value - tax 7175000
(ii) Lets arrange the projects in order of IRR(Highest 1st)
Project Size IRR
A 650000 14 Retained Earnings Available 2500000
B 1050000 13.5 WACC - 10%
C 1000000 11.2 For new fund wacc = 10.80%
D 1200000 11
E 500000 10.7
F 650000 10.3
G 700000 10.2
We should select A,B,C,D only
as D,E,F,G has lower IRR then cost of additional funds.
Optimal Capital budget =
Project Size
A 650000
B 1050000
C 1000000
D 1200000
3900000
Out of 3900000, 2500000 if financed through retained earnings and the balance by issue of new shares
New shares = 1400000

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