Question

OPTIMAL CAPITAL BUDGET

Hampton Manufacturing estimates that its WACC is 12.5%. The company is considering the following seven investment projects:

Project	Size	IRR
A	$750,000	14.0%
B	1,250,000	13.5
C	1,250,000	13.2
D	1,250,000	13.0
E	750,000	12.7
F	750,000	12.3
G	750,000	12.2

1. 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.
   $

2. Now assume that Projects C and D are mutually exclusive. Project D has an NPV of $400,000, whereas Project C has an NPV of $350,000. 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.
   $

3. Ignore Part b 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 of those projects 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.
   $

Answer 1