Mindtapv2.0 Finance, 1 Term (6 Months) Printed Access Card For Brigham/houston's Fundamentals Of Financial Management, 15th (mindtap Course List)
15th Edition
ISBN: 9780357114575
Author: Eugene F. Brigham, Joel F. Houston
Publisher: Cengage Learning
expand_more
expand_more
format_list_bulleted
Concept explainers
Videos
Textbook Question
Chapter 13, Problem 5P
OPTIMAL CAPITAL BUDGET Hampton Manufacturing estimates that its VVACC is 125%. The company is considering the following 7 investment projects:
| Project | Size | |
| 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 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, and what Is the firm’s optimal capital budget?
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
CAPITAL BUDGETING CRITERIA You must analyze two projects, X and Y. Each
project costs $10,000, and the firm's WACC is 12%. The expected net cash flows are
as follows:
1
2
4
Project X
Project Y
-$10,000
-$10,000
$6,500
$3,500
$3,000
$3,500
$3,000
$3,500
$1,000
$3,500
Calculate each projecť's NPV, IRR, MIRR, payback, and discounted payback.
b. Which project(s) should be accepted if they are independent?
c. Which project(s) should be accepted if they are mutually exclusive?
a.
с.
How might a change in the WACC produce a conflict between the NPV and IRR
rankings of the two projects? Would there be a conflict if WACC were 5%? (Hint: Plot
the NPV profiles. The crossover rate is 6.21875%.)
e. Why does the conflict exist?
Excel Online Structured Activity: WACC and optimal capital budget
Adamson Corporation is considering four average-risk projects with the following costs and rates of return:
Project
Cost
Expected Rate of Return
1
$2,000
16.00%
2
3,000
15.00
3
5,000
13.75
4
2,000
12.50
The company estimates that it can issue debt at a rate of ra = 11%, and its tax rate is 30%. It can issue preferred stock that pays a
constant dividend of $5 per year at $59 per share. Also, its common stock currently sells for $30 per share; the next expected dividend, D1,
is $3.25; and the dividend is expected to grow at a constant rate of 6% per year. The target capital structure consists of 75% common
stock, 15% debt, and 10% preferred stock. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and
perform the required analysis to answer the questions below.
Open spreadsheet
a. What is the cost of each of the capital components? Round your answers to two decimal places. Do not…
Capital Budgeting Methods Project S has a cost of $10,000 and is expected to produce benefits (cash flows) of $3,000 per year for 5 years. Project L costs $25,000 and is expected to produce cash flows of $7,400 per year for 5 years. Calculate the two projects’ NPVs, IRRs, MIRRs, and PIs, assuming a cost of capital of 12%. Which project would be selected, assuming they are mutually exclusive, using each ranking method? Which should actually be selected?
Chapter 13 Solutions
Mindtapv2.0 Finance, 1 Term (6 Months) Printed Access Card For Brigham/houston's Fundamentals Of Financial Management, 15th (mindtap Course List)
Ch. 13 - Explain in general terms what each of the...Ch. 13 - Would a failure to recognize growth options tend...Ch. 13 - Companies often have to increase their initial...Ch. 13 - How might a firms corporate WACC be affected by...Ch. 13 - Prob. 5QCh. 13 - GROWTH OPTION Singh Development Co. is deciding...Ch. 13 - OPTIMAL CAPITAL BUDGET Marble Construction...Ch. 13 - Prob. 3PCh. 13 - ABANDONMENT OPTION The Scampini Supplies Company...Ch. 13 - OPTIMAL CAPITAL BUDGET Hampton Manufacturing...
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Capital Budgeting Techniques Analyze the two independent projects, X and Y. Each project costs $10,000, and the firm’s required rate of return is 12%. The expected net cash flows are as follows: Outflows Inflows Projects Year 1 2 3 4 X -10,000 6,500 3,000 3,000 1,000 Y -10,000 3,500 3,500 3,500 5,500 Required: Calculate for each project: Payback Period IRR NPV PI Give your decision regarding acceptation and rejection of the project. Explain which criteria you based your decision upon and why?arrow_forwardCAPITAL BUDGETING CRITERIA Your division is considering two projects. Its WACC is 10%, and the projects’ after-tax cash flows (in millions of dollars) would be as follows: REFER IMAGE a. Calculate the projects’ NPVs, IRRs, MIRRs, regular paybacks, and discounted paybacks.b. If the two projects are independent, which project(s) should be chosen?c. If the two projects are mutually exclusive and the WACC is 10%, which project(s) should be chosen?d. Plot NPV profiles for the two projects. Identify the projects’ IRRs on the graph.e. If the WACC was 5%, would this change your recommendation if the projects were mutually exclusive? If the WACC was 15%, would this change your recommendation? Explain your answers.f. The crossover rate is 13.5252%. Explain what this rate is and how it affects the choice between mutually exclusive projects.g. Is it possible for conflicts to exist between the NPV and the IRR when independent projects are being evaluated? Explain your answer.h. Now look at the…arrow_forwardXYZ, Inc. is evaluating several capital budgeting projects which are summarized in the table below. The cost of capital for XYZ is 8%. Project A B C D NPV $1,000 $1,500 $1,200 ($400) IRR 25% 12% 15% 5% Payback Period (years) 4.0 3.0 2.0 1.5 If these projects are mutually exclusive, then XYZ should accept project(s) Question 5 options: A B C Darrow_forward
- A firm with a 14% WACC is evaluating two projects for this year’s capital budget. After-tax cash flows, including depreciation, are below. Calculate the NPV for each and determine which project the firm should pick. Time Project A Project B 0 -$30,000 -$90,000 1 $10,000 $28,000 2 $10,000 $28,000 3 $10,000 $28,000 4 $10,000 $28,000 5 $10,000 $28,000arrow_forwardCapital Budgeting Methods Project S has a cost of $11,000 and is expected to produce benefits (cash flows) of $3,400 per year for 5 years. Project L costs $23,000 and is expected to produce cash flows of $6,900 per year for 5 years. Calculate the two projects' NPVs, assuming a cost of capital of 14%. Do not round intermediate calculations. Round your answers to the nearest cent. Project S: $ Project L: $ Which project would be selected, assuming they are mutually exclusive? Based on the NPV values, Project S/Project L would be selected. Calculate the two projects' IRRs. Do not round intermediate calculations. Round your answers to two decimal places. Project S: % Project L: % Which project would be selected, assuming they are mutually exclusive? Based on the IRR values, Project S/Project L would be selected. Calculate the two projects' MIRRs, assuming a cost of capital of 14%. Do not round intermediate calculations. Round your answers to two decimal places. Project S: %…arrow_forwardCapital Budgeting Assume you are evaluating two mutually exclusive projects, the cash flows of which appear below and that your company uses a cost of capital of 13% to evaluate projects such as these. Time Project A Cash Flows Project B Cash Flows 0 -$46,800 -$63,600 1 -21,600 20,400 2 43,200 20,400 3 43,200 20,400 4 43,200 20,400 5 -28,800 20,400 If Project A and Project B are independent, which project should be undertaken?arrow_forward
- Consider that you are evaluting the following projects to undertake as per your capital budgeting activity You have capital budget constarin of 10,000. Project #3 and Project#4 are mutually exclusive. You have extimated your WACC as 12%.arrow_forwardCapital Budgeting Assume you are evaluating two mutually exclusive projects, the cash flows of which appear below and that your company uses a cost of capital of 13% to evaluate projects such as these. Time Project A Cash Flows Project B Cash Flows 0 -$46,800 -$63,600 1 -21,600 20,400 2 43,200 20,400 3 43,200 20,400 4 43,200 20,400 5 -28,800 20,400 Calculate the IRR and MIRR of projects A & B. Assume a reinvestment rate of 13% for the calculation of MIRR.arrow_forwardCapital Budgeting Assume you are evaluating two mutually exclusive projects, the cash flows of which appear below and that your company uses a cost of capital of 13% to evaluate projects such as these. Time Project A Cash Flows Project B Cash Flows 0 -$46,800 -$63,600 1 -21,600 20,400 2 43,200 20,400 3 43,200 20,400 4 43,200 20,400 5 -28,800 20,400 Under what conditions on the cost of capital should project B be preferred to project A?arrow_forward
- Capital budgeting criteria: mutually exclusive projects A firm with a WACC of 10% is considering the following mutually exclusive projects: 4 + + Project A Project B -$350 $60 $60 $60 $235 $235 -$700 $200 $200 $80 $80 $80 Which project would you recommend? 3.arrow_forwardCapital Budgeting Assume you are evaluating two mutually exclusive projects, the cash flows of which appear below and that your company uses a cost of capital of 13% to evaluate projects such as these. Time Project A Cash Flows Project B Cash Flows 0 -$46,800 -$63,600 1 -21,600 20,400 2 43,200 20,400 3 43,200 20,400 4 43,200 20,400 5 -28,800 20,400 Sketch the NPV profile for projects A & B.arrow_forwardCapital Budgeting Methods Project S has a cost of $10,000 and is expected to produce benefits (cash flows) of $3,000 per year for 5 years. Project L costs $25,000 and is expected to produce cash flows of $7,400 per year for 5 years. Calculate the two projects' NPVS, assuming a cost of capital of 12%. Do not round intermediate calculations. Round your answers to the nearest cent. Project S: $ Project L: $ Which project would be selected, assuming they are mutually exclusive? Based on the NPV values, Select- v would be selected. Calculate the two projects' IRRS. Do not round intermediate calculations. Round your answers to two decimal places. Project S: % Project L: % Which project would be selected, assuming they are mutually exclusive? Based on the IRR values, -Select- would be selected. Calculate the two projects' MIRRS, assuming a cost of capital of 12%. Do not round intermediate calculations. Round your answers to two decimal places. Project S: % Project L: % Which project would be…arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Capital Budgeting Introduction & Calculations Step-by-Step -PV, FV, NPV, IRR, Payback, Simple R of R; Author: Accounting Step by Step;https://www.youtube.com/watch?v=hyBw-NnAkHY;License: Standard Youtube License