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5 Oct 2018

A company has a WACC1=12.5% for funding up to $4 million when retained earnings are used. They also have a WACC2=13.7% for funding above $4 million when new equity is raised. If they have the following independent investment opportunities, which projects should the company include in their budget? What is the company’s optimal capital budget?

Project A: Cost of $2 million; IRR 20%.
Project B: Cost of $3 million; IRR 14%
Project C: Cost of $4 million; IRR 13%

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Elin Hessel
Elin HesselLv2
7 Oct 2018

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Related questions

Texas Transport has five possible investment projects for the coming year. Each project is indivisible. They are:

Project Investment (million IRR

A $ 6 18%

B $10 15%

C $9 20%

D $4 12%

E $3 24%

The firm's weighted marginal cost of capital schedule is 12 percent for up to $6 million of investment; 16 percent for between $6 million and $18 million of investment; and above $18 million the weighted cost of capital is 18 percent. The optimal capital budget is:

$12 million.

$18 million.

$23 million.

$28 million.

Dirty Dogs Grooming’s optimal capital structure calls for 40 percent debt and 60 percent common equity. The company’s weighted average cost of capital (WACC) is 10 percent if the amount of retained earnings generated during the year is sufficient to fund the equity portion of its capital budgeting requirements, whereas its WACC is 14 percent if new common stock must be issued. Dirty Dogs has the following independent investment opportunities:

Project A: Cost = $684,000; IRR = 16%

Project B: Cost = $640,000; IRR = 13%

Project C: cost = $660,000; IRR = 9%

If Dirty Dogs expects to generate net income of $720,000 and it pays dividends according to the residual policy, what will its dividend payout ratio be?

Dirty Dogs Grooming’s optimal capital structure calls for 40 percent debt and 60 percent common equity. The company’s weighted average cost of capital (WACC) is 10 percent if the amount of retained earnings generated during the year is sufficient to fund the equity portion of its capital budgeting requirements, whereas its WACC is 14 percent if new common stock must be issued. Dirty Dogs has the following independent investment opportunities:

Project A: Cost = $684,000; IRR = 16% Project B: Cost = $640,000; IRR = 13% Project C: cost = $660,000; IRR = 9%

If Dirty Dogs expects to generate net income of $720,000 and it pays dividends according to the residual policy, what will its dividend payout ratio be?

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