Question

15.  Problem 10.19 - Adjusting Cost of Capital for Risk

Click here to read the eBook: Adjusting the Cost of Capital for Risk ADJUSTING COST OF CAPITAL FOR RISK Ziege Systems is considering the following independent projects for the coming year: Project Required Investment Rate of Return Risk A $4 million 10.75% High B 5 million 13.25 High C 3 million 8.75 Low D 2 million 8.5 Average E 6 million 11.75 High F 5 million 11.75 Average G 6 million 6.5 Low H 3 million 10.25 Low Ziege's WACC is 9.25%, but it adjusts for risk by adding 2% to the WACC for high-risk projects and subtracting 2% for low-risk projects. Which projects should Ziege accept if it faces no capital constraints? Project A -Select-AcceptRejectItem 1 Project B -Select-AcceptRejectItem 2 Project C -Select-AcceptRejectItem 3 Project D -Select-AcceptRejectItem 4 Project E -Select-AcceptRejectItem 5 Project F -Select-AcceptRejectItem 6 Project G -Select-AcceptRejectItem 7 Project H -Select-AcceptRejectItem 8 If Ziege can only invest a total of $13 million, which projects should it accept? Project A -Select-AcceptRejectItem 9 Project B -Select-AcceptRejectItem 10 Project C -Select-AcceptRejectItem 11 Project D -Select-AcceptRejectItem 12 Project E -Select-AcceptRejectItem 13 Project F -Select-AcceptRejectItem 14 Project G -Select-AcceptRejectItem 15 Project H -Select-AcceptRejectItem 16 If Ziege can only invest a total of $13 million, what would be the dollar size of its capital budget? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. $ ? million 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 -Select-AcceptRejectItem 18 Project B -Select-AcceptRejectItem 19 Project C -Select-AcceptRejectItem 20 Project D -Select-AcceptRejectItem 21 Project E -Select-AcceptRejectItem 22 Project F -Select-AcceptRejectItem 23 Project G -Select-AcceptRejectItem 24 Project H -Select-AcceptRejectItem 25 What would be the dollar size of its capital budget? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. $ ? million

Answer 1

Project	Investment	Return	Risk	WACC	Select
A	4 million	10.75%	High	11.25%	No
B	5 million	13.25	High	11.25%	Yes
C	3 million	8.75	Low	7.25%	Yes
D	2 million	8.5	Average	9.25%	No
E	6 million	11.75	High	11.25%	Yes
F	5 million	11.75	Average	9.25%	Yes
G	6 million	6.5	Low	7.25%	No
H	3 million	10.25	Low	7.25%	Yes

Select projects if returns are greater than WACC.

With capital constraints, select the projects with maximum difference of Returns - WACC.

Project	Investment	Return	Risk	WACC	Select
A	4 million	10.75%	High	11.25%	No
B	5 million	13.25%	High	11.25%	Yes
C	3 million	8.75%	Low	7.25%	No
D	2 million	8.50%	Average	9.25%	No
E	6 million	11.75%	High	11.25%	No
F	5 million	11.75%	Average	9.25%	Yes
G	6 million	6.50%	Low	7.25%	No
H	3 million	10.25%	Low	7.25%	Yes

With additional capital, only c can be added.

Project	Investment	Return	Risk	WACC	Select
A	4 million	10.75%	High	11.25%	No
B	5 million	13.25%	High	11.25%	Yes
C	3 million	8.75%	Low	8.25%	Yes
D	2 million	8.50%	Average	9.25%	No
E	6 million	11.75%	High	11.25%	No
F	5 million	11.75%	Average	9.25%	Yes
G	6 million	6.50%	Low	7.25%	No
H	3 million	10.25%	Low	7.25%	Yes

Capital Budget = 16 million