Bryant Manufacturing is considering the following capital projects. The internal

Question

Bryant Manufacturing is considering the following capital projects. The internal rate of return (IRR) has been calculated for each project. The optimal capital budget (OCB) is the budget size that maximizes the firm's wealth given the opportunities for investment and the cost of capital. Bryant's managers have plotted the marginal cost of capital (MCC) schedule to reflect how the cost of capital increases as new capital is raised. Assume that the proposed projects are independent and equally risky and that their risks are equal to Bryant's average existing assets. Refer to the preceding graph, and place the black point (X symbol) at the point that represents the OCB to find the answer. What is the optimal capital budget? What is the weighted average cost of capital (WACC) at the optimal capital budget?

Explanation / Answer

Optimal capital budget is the budget till when the returns exceed the cost. The returns are shown through IRR and cot is the WACC. IRR and WACC are equal at 110 and thereafter any new capital invested shall give negative returns. Accordingly, OCB is 110. WACC at OCB is 11% as per the diagram.

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