Capital Budgeting DecisionsEXERCISE 13-7 Net Present Value Analysis of Two Alternatives LO13-2Perit Industries has $100,000 to invest. The company is trying to decide between two alternativene.uses of the funds. The alternatives are:aceyProject A Project BCost of equipment required ..Working capital investment requiredAnnual cash inflows ..Salvage value of equipment in six yearsLife of the project .$100,000$0...$0 $100,000$21,000$8,000$16,000$06 years6 yearsThe working capital needed for project B will be released at the end of six years for investmentelsewhere. Perit Industries' discount rate is 14%.Required:1. Compute the net present value of Project A.. Compute the net present value of Project B.3. Which investment alternative (if either) would you recommend that the company accept?

1. Compute net present value of project A: Note: 3.889 value from PVIFA factor table @14%, 6th…

Answered: Capital Budgeting Decisions EXERCISE…

EBK CFIN

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ISBN:9781337671743

Author:BESLEY

Publisher:BESLEY

Chapter9: Capital Budgeting Techniques

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OPTIMAL CAPITAL BUDGET Hampton Manufacturing estimates that its WACC is 125%. 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 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?
OPTIMAL CAPITAL BUDGET Marble Construction estimates that its WACC is 10% if equity comes from retained earnings. However, if the company issues new stock to raise new equity, it estimates that its WACC will rise to 10.8%. The company believes that it will exhaust its retained earnings at 2,500,000 of capital due to the number of highly profitable projects available to the firm and its limited earnings. The company is considering the following 7 investment projects: Project Size IRR A 650,000 14.0% B 1,050,000 13.5 C 1,000,000 11.2 D 1,200,000 11.0 E 500,000 10.7 F 650,000 10.3 G 700,000 10.2 Assume that each of these projects is independent and that each is just as risky as the firms existing assets. Which set of projects should be accepted, and what is the firms optimal capital budget?
WACC AND OPTIMAL CAPITAL BUDGET Adams Corporation is considering four average-risk protects 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 rd = 10%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of 500 per year at 4900 per share. Also, its common stock currently sells for 36.00 per share; the next expected dividend, D1 is 3.50; 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. a. What is the cost of each of the capital components? b. What is Adams WACC? c. Only projects with expected returns that exceed WACC will be accepted. Which projects should Adams accept?

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