Question

Hampton Manufacturing estimates that its WACC is 12.6%. The company is considering the following seven investment projects:

Project	Size			IRR
A		$ 700,000		14.3	%
B		1,100,000		13.8
C		1,100,000		13.2
D		1,100,000		13.0
E		500,000		12.7
F		500,000		12.1
G		900,000		12.0

1. Assume that each of these projects is independent and that each is just as risky as the firm's existing assets. What is the firm's optimal capital budget? Write out your answer completely. For example, 13 million should be entered as 13,000,000. Round your answer to the nearest dollar.

2. Now, assume that Projects C and D are mutually exclusive. Project D has an NPV of $350,000, whereas Project C has an NPV of $400,000. What is the firm's optimal capital budget in this case? Write out your answer completely. For example, 13 million should be entered as 13,000,000. Round your answer to the nearest dollar.

3. Ignore the previous part, and now assume that each of the projects is independent but that management decides to incorporate project risk differentials. Management judges Projects B, C, D, and E to have average risk, Project A to have high risk, and Projects F and G to have low risk. The company adds 2% to the WACC of those projects that are significantly more risky than average, and it subtracts 2% from the WACC for those that are substantially less risky than average. What is the firm's optimal capital budget in this case? Write out your answer completely. For example, 13 million should be entered as 13,000,000. Round your answer to the nearest dollar.

Answer 1

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