Question

9.  Problem 12.17 (Optimal Capital Budget)

eBook Hampton Manufacturing estimates that its WACC is 12.8%. The company is considering the following seven investment projects: Project Size IRR A $ 650,000 14.5 % B 1,150,000 14.0 C 1,150,000 13.7 D 1,250,000 13.5 E 800,000 13.2 F 800,000 12.6 G 750,000 12.3 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 -Select-acceptdon't acceptItem 1 Project B -Select-acceptdon't acceptItem 2 Project C -Select-acceptdon't acceptItem 3 Project D -Select-acceptdon't acceptItem 4 Project E -Select-acceptdon't acceptItem 5 Project F -Select-acceptdon't acceptItem 6 Project G -Select-acceptdon't acceptItem 7 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. $   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. Which set of projects should be accepted? Project A -Select-acceptdon't acceptItem 9 Project B -Select-acceptdon't acceptItem 10 Project C -Select-acceptdon't acceptItem 11 Project D -Select-acceptdon't acceptItem 12 Project E -Select-acceptdon't acceptItem 13 Project F -Select-acceptdon't acceptItem 14 Project G -Select-acceptdon't acceptItem 15 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. $   Ignore 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. Which set of projects should be accepted? Project A -Select-acceptdon't acceptItem 17 Project B -Select-acceptdon't acceptItem 18 Project C -Select-acceptdon't acceptItem 19 Project D -Select-acceptdon't acceptItem 20 Project E -Select-acceptdon't acceptItem 21 Project F -Select-acceptdon't acceptItem 22 Project G -Select-acceptdon't acceptItem 23 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

Project	Size	IRR
A	650,000	14.50%
B	1,150,000	14.00%
C	1,150,000	13.70%
D	1,250,000	13.50%
E	800,000	13.20%
F	800,000	12.60%
G	750,000	12.30%
The projects whose return i.e. IRR is greater than the cost of capital should be accepted
Project	Decision
A	Accept
B	Accept
C	Accept
D	Accept
E	Accept
F	Reject
G	Reject
Optimal Capital Budget	5,000,000
b.The project with higher NPV should be selected
Project	Decision
A	Accept
B	Accept
C	Accept
D	Reject
E	Accept
F	Reject
G	Reject
Optimal Capital Budget	3,750,000
c.
Project	Size	IRR	Required return	Decision
A	650,000	14.50%	14.8	Reject
B	1,150,000	14.00%	12.8	Accept
C	1,150,000	13.70%	12.8	Accept
D	1,250,000	13.50%	12.8	Accept
E	800,000	13.20%	12.8	Accept
F	800,000	12.60%	10.8	Accept
G	750,000	12.30%	10.8	Accept
Capital Budget	5,900,000