OPTIMAL CAPITAL BUDGET
Hampton Manufacturing estimates that is WACC is 12 %.
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
A. 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, and what is the firm's optimal capital budget?
B. 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, and what is the firm's optimal capital budget?
C. 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 percent to the WACC of those projects that are significantly more risky than average, and it subtracts 2 percent from the WACC for those that are substantially less risky than average. Which set of projects should be accepted, and what is the firm's optimal capital budget?
OPTIMAL CAPITAL BUDGET
Hampton Manufacturing estimates that is WACC is 12 %.
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
A. 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, and what is the firm's optimal capital budget?
B. 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, and what is the firm's optimal capital budget?
C. 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 percent to the WACC of those projects that are significantly more risky than average, and it subtracts 2 percent from the WACC for those that are substantially less risky than average. Which set of projects should be accepted, and what is the firm's optimal capital budget?
Related questions
The mangers of United Medtronicss are evaluating the following four projects for the coming budget period. The firms corporate cost of capital is 14 percent.
| | ||||||||||||||||||
| Project | Cost | IRR | ||||||||||||||||
| A | $15,000 | 17% | ||||||||||||||||
| B | $15,000 | 16% | ||||||||||||||||
| C | $12,000 | 15% | ||||||||||||||||
| D | $20,000 | 13% | ||||||||||||||||
| a. What is the firm's optimal capital budget? b. Now, suppose Medtronic's managers want to consider differential risk in the capital budgeting process. Project A has average risk, B has below-average risk, C has above-average risk, and D has average risk. What is the firm's optimal capital budget when differential risk is considered? (Hint: The firm's managers lower the IRR of high-risk projects by 3 percentage points and raise the IRR of low-risk projects by the same amount.) | ||||||||||||||||||
