Question

12.5

Marble Construction estimates that its WACC is 9% 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 9.6%. The company believes that it will exhaust its retained earnings at $2,600,000 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 $ 610,000 1,040,000 1,050,000 1,190,000 470,000 610,000 680,000 IRR 13.6% 13.8 10.0 9.3 9.4 8.9 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 -Select- Project B -Select- Project C Project D -Select- -Select- -Select- Project E Project F -Select- Project G -Select- What is the firm's optimal capital budget? Round your answer to the nearest dollar.

Answer 1

As company is planning to exhaust retained earnings which means they will be issuing the new stocks and this will increase the WACC to 9.6%. So any project where IRR is less than that will be rejected.

Project	Size
Project A	Accept
Project B	Accept
Project C	Accept
Project D	Reject
Project E	Reject
Project F	Reject
Project G	Accept

Optimal Capital Budget would be 3,380,000. Total of Project A, Project B, Project C and Project G because in all the projects IRR is higher than the cost of Capital.