The managers of United Medtronics are evaluating the following four projects for
ID: 2715334 • Letter: T
Question
The managers of United Medtronics are evaluating the following four projects for the coming budget period. The firms corporate cost of capital is 14 percent. Project Cost IRR A $ 15,000 17% B 15,000 16 C 12,000 15 D 20,000 13 A.What is the firm's optimal capital budget? b. Now, suppose Medtronic's managers want to consider differential risk in the capital budgeting process. Project A has average risk, B has below-average risk, C has above-average risk, and D has average risk. What is the firm's optimal capital budget when differential risk is considered? (Hint: The firm's managers lower the IRR of high-risk projects by 3 percentage points and raise the IRR of low-risk projects by the same amount. The managers of United Medtronics are evaluating the following four projects for the coming budget period. The firms corporate cost of capital is 14 percent. Project Cost IRR A $ 15,000 17% B 15,000 16 C 12,000 15 D 20,000 13 A.What is the firm's optimal capital budget? b. Now, suppose Medtronic's managers want to consider differential risk in the capital budgeting process. Project A has average risk, B has below-average risk, C has above-average risk, and D has average risk. What is the firm's optimal capital budget when differential risk is considered? (Hint: The firm's managers lower the IRR of high-risk projects by 3 percentage points and raise the IRR of low-risk projects by the same amount.Explanation / Answer
For a project to be pursued, IRR of project should be more than firms cost of capital
a. Project A, B and C have greater IRR than firms cost of capital
therefore optimal budget = 15000 + 15000 + 12000 = 42000
b. IRRs of project after adjusting for project specefic risk:
A = 17%
B = 16 + 3 = 19%
C = 15 - 3 = 12%
D = 13%
Now only projects A and B are optimal to pursue
therefore optimal capital budget = 15000 + 15000 = 30000
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