Fundamentals of Financial Management
15th Edition
ISBN: 9780357307724
Author: Brigham
Publisher: CENGAGE L
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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?
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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
Fundamentals of Financial Management
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...
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