Question

Ziege Systems is considering the following independent projects for the coming year:

Project	Required Investment	Rate of Return	Risk
A	$4 million	11.50%	High
B	5 million	14.00	High
C	3 million	9.50	Low
D	2 million	9.25	Average
E	6 million	12.50	High
F	5 million	12.50	Average
G	6 million	7.25	Low
H	3 million	11.50	Low

Ziege's WACC is 10.00%, but it adjusts for risk by adding 2% to the WACC for high-risk projects and subtracting 2% for low-risk projects.

1. Which projects should Ziege accept if it faces no capital constraints?

   Project A	Reject 1
   Project B	Accept 2
   Project C	Accept 3
   Project D	Reject 4
   Project E	Accept 5
   Project F	Accept 6
   Project G	Reject 7
   Project H	Accept 8

2. If Ziege can only invest a total of $13 million, which projects should it accept?

   Project A	Reject 9
   Project B	Accept 10
   Project C	Reject 11
   Project D	Reject 12
   Project E	Reject 13
   Project F	Accept 14
   Project G	Reject 15
   Project H	Accept 16

   If Ziege can only invest a total of $13 million, what would be the dollar size of its capital budget? Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answer to two decimal places.

   $    million

3. Suppose Ziege can raise additional funds beyond the $13 million, but each new increment (or partial increment) of $5 million of new capital will cause the WACC to increase by 1%. Assuming that Ziege uses the same method of risk adjustment, which projects should it now accept?

   Project A	Reject 18
   Project B	Accept 19
   Project C	Accept 20
   Project D	Reject 21
   Project E	Accept 22
   Project F	Reject 23
   Project G	Accept 24
   Project H	-Select-AcceptRejectItem 25

   What would be the dollar size of its capital budget? Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answer to two decimal places. $    million

Answer 1

a) Evaluation of Projects-

Project	Required Investment	Risk	WACC	Rate of Return	Rate of Return-WACC	Decision
A	$4 Million	High	12%	11.50%	-0.50%	Reject
B	$5 Million	High	12%	14%	2%	Accept
C	$3 Million	Low	8%	9.50%	1.50%	Accept
D	$2 Million	Average	10%	9.25%	-0.75%	Reject
E	$6 Million	High	12%	12.50%	0.50%	Accept
F	$5 Million	Average	10%	12.50%	2.50%	Accept
G	$6 Million	Low	8%	7.25%	-0.75%	Reject
H	$3 Million	Low	8%	11.50%	3.50%	Accept

b) Evaluation of projects and dollar size of capital budget-

Project	Rate of Return-WACC	Rank	Investment	Decision
B	2%	III	$5 Million	Accept
C	1.50%	IV	$3 Million	Reject
E	0.50%	V	$6 Million	Reject
F	2.50%	II	$5 Million	Accept
H	3.50%	I	$3 Million	Accept

Capital Budget

Project H- $3 Million

Project F- $5 Million

Project B- $5 Million

Total- $13 Million

c) Evaluation of incremental raising of funds-

Project	Rate of Return-WACC(A)	Required Invesment	Incremental WACC(B)	Column A- ColumnB	Decision
C	1.50%	$3 Million	1%	0.50%	Accept
E	0.50%	$6 Million	2%	-1.50%	Reject

Capital Budget will be-

$13 Million+$3 Million

= $16 Million