Optimal Capital Budget Marble Construction estimates that its WACC is 10% if equ

Question

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 seven investment projects:

What is the firm's optimal capital budget? Write out your answer completely. For example, 13 million should be entered as 13,000,000.

$   

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

Explanation / Answer

SOLUTION:

Calculation of Optimal Capital Budget:

Project A:

= $650,000 ( 1 - .14 ) / 0.108

Project A = $5,175,925.92

Project B:

= $1,050,000 ( 1 - .135 ) / 0.108

Project B = $8,409,722.22

Project C:

= $1,000,000 ( 1 - .112 ) / 0.108

Project C = $8,222,222.22

Project D:

= $1,200,000 ( 1 - .11 ) / 0.108

Project C = $9,888,888.88

Project E:

= $500,000 ( 1 - .107 ) / 0.108

Project C = $4,134,259.25

Project F:

= $650,000 ( 1 - .103 ) / 0.108

Project C = $5,398,611.11

Project G:

= $700,000 ( 1 - .102 ) / 0.108

Project C = $5,820,370.37

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