OPTIMAL CAPITAL BUDGET Hampton Manufacturing estimates that its WACC is 12.5%. T

Question

OPTIMAL CAPITAL BUDGET Hampton Manufacturing estimates that its WACC is 12.5%. The company is considering the following seven 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 13.0 750,000 12.7 750,000 12.3 750,000 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? Project -Select- 4 Project -Select- 4 Project -Select- Project -Select- Project -Select > Project -Select- Project -Select- What is the firm's optimal capital budget? Write out your answer completely. For example, 13 million should be entered as 13,000,000 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? Project -Select* Project -Select- 4 Project -Select4

Explanation / Answer

1

All projects having IRR more than 12.5% should be accepted
So, A,B,C,D,E should be accepted

Optimal capital budget=750000+1250000+1250000+1250000+750000=5250000

2

If projects C and D are mutually exclusive, we will select higher NPV project that is Project D
So, we will select A,B,D,E
Firm's Optimal Capital Budget=750000+1250000+1250000+750000=4000000

3

Risk adjusted WACC
A 12.5+2=14.5%
B 12.5%
C 12.5%
D 12.5%
E 12.5%
F 12.5-2=10.5%
G 12.5-2=10.5%

All projects having IRR more than Risk adjusted WACC would be accepted

Hence, we will select Projects B,C,D,E,F,G

Optimal Capital Budget=1250000+1250000+1250000+750000+750000+750000=6000000

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