Vang Enterprises, which is debt-free and finances only with equity from retained

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 = 0.98. 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? Risk Expected Cost Project Risk Factor Return (Millions) 1 Very low -2.00% 7.60% $25.0 2 Low -1.00% 9.15% $25.0 3 Average 0.00% 10.10% $25.0 4 High 1.00% 10.40% $25.0 5 Very high 2.00% 10.80% $25.0 6 Very high 2.00% 10.90% $25.0 7 Very high 2.00% 13.00% $25.0 a. $ 50 b. $ 25 c. $ 75 d. $100 e. $ 0

Explanation / Answer

Cost of Equity=rf+beta*(Risk preimum) Cost of Equity=4.5%+.98*(5.5%) 9.89% Project Risk factor Cost of Equity +risk factor Exp return Investment where Exp return > Cost of equity 1 -2.00% 7.89% 7.60% 0 2 -1.00% 8.89% 9.15% 25 3 0.00% 9.89% 10.10% 25 4 1.00% 10.89% 10.40% 0 5 2.00% 11.89% 10.80% 0 6 2.00% 11.89% 10.90% 0 7 2.00% 11.89% 13.00% 25 Total Capital Budget 75

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