Vang Enterprises, which is debt-free and finances only with equity from retained
ID: 2780802 • Letter: V
Question
Vang Enterprises, which is debt-free and finances only with equity from retained earnings, is considering 7 equal-sized capital budgeting projects. Its CFO hired you to assist in deciding whether none, some or all of the projects should be accepted. You have the following information: rRF-4.50%; RPM-5-50%; and b-o 98 The company adds or subtracts a specified percentage to the corporate WACC when it evaluates projects that have above- or below-average risk. Data on the 7 projects are shown below. If these are the only projects under consideration, how large should the capital budget be? Expected Pro Risk Very low Low Average High Very high Very high Very high Risk factor return Cost (millions $25.0 $25.0 -2.00% -1.00% 0.00% 1.00% 2.00% 2.00% 2.00% 9.15% 0.10% 10.40% 10.80% 10.90% 13.00% $25.0 $25.0 $25.0 $25.0 $25.0Explanation / Answer
cost of equity or cost of capital
risk free rate+(market risk premium)*beta
4.5+(5.5)*.98
9.89
project cost of capital = cost of capital+ risk factor
Project
cost of capital
risk factor
project cost of capital
expected return
amount invested
A
9.89
-2
7.89
7.6
0
B
9.89
-1
8.89
9.15
25
C
9.89
0
9.89
10.1
25
E
9.89
1
10.89
10.4
0
F
9.89
2
11.89
10.8
0
G
9.89
2
11.89
10.9
0
H
9.89
2
11.89
13
25
total capital budget
75
cost of equity or cost of capital
risk free rate+(market risk premium)*beta
4.5+(5.5)*.98
9.89
project cost of capital = cost of capital+ risk factor
Project
cost of capital
risk factor
project cost of capital
expected return
amount invested
A
9.89
-2
7.89
7.6
0
B
9.89
-1
8.89
9.15
25
C
9.89
0
9.89
10.1
25
E
9.89
1
10.89
10.4
0
F
9.89
2
11.89
10.8
0
G
9.89
2
11.89
10.9
0
H
9.89
2
11.89
13
25
total capital budget
75
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