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OPTIMAL CAPITAL BUDGET Hampton Manufacturing estimates that its VVACC is 125%. The company is considering the following 7 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?

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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285867977
BuyFind

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285867977

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Chapter
Section
Chapter 13, Problem 5P
Textbook Problem

OPTIMAL CAPITAL BUDGET Hampton Manufacturing estimates that its VVACC is 125%. The company is considering the following 7 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
  1. 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?
  2. 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?
  3. 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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