Problem 12-5 Optimal Capital Budget Marble Construction estimates that its WACC
ID: 2790172 • Letter: P
Question
Problem 12-5 Optimal Capital Budget Marble Construction estimates that its WACC is 10% if equity comes from retained earnings. However, if the company issues new stock to raise new equity, it estimates that its WACC will rise to 10.8%. The company believes that it will exhaust its retained earnings at $2,500,000 of capital due to the number of highly profitable projects available to the firm and its limited earnings. The company is considering the following seven investment projects: Project Size, $ IRR, % A 650,000 14.0 B 1,050,000 13.5 C 1,000,000 11.2 D 1,200,000 11.0 E 500,000 10.7 F 650,000 10.3 G 700,000 10.2 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 A a. Project B b. Project C c. Project D d. Project E e. Project F f. Project G g. What is the firm's optimal capital budget? Write out your answer completely. For example, 13 million should be entered as 13,000,000. $
Explanation / Answer
a)since The IRR of project E ,F & G is lower than cost of new equity (10.8%) ,therefore this project should not be selected.
Project to be accepted : A,B,C,D
B)OPtimal capital Budget : cost of project to be accepted
= 650000+1050000+1000000+1200000
= $ 3,900,000