Question

The Ajax Corporation has the following set of projects available to it: ITT Investment Required Expected Rate of Return ($ Million) Project (%) 500 A 23.0 175 18.0 50 21.0 125 16.0 E 300 14.0 150 13.0 250 19.0 Note: All projects have equal risk. Calculate the cumulative investment and complete Ajax's schedule of potential projects. (Hint: Ajax prioritizes projects according to their expected rates TTT of return.) Investment Required Expected Rate of Return Cumulative Investment ($ Million) Project ($ Million) (%) 500 23.0 500 50 21.0 550 18.0 975 175 1,400 300 14.0 Ajax can raise funds with the following marginal costs. Calculate the cumulative funds raised to complete the following table. Block of Funds Cost of Capital Cumulative Funds Raised ($ Million) (%) ($ Million) First 250 14.0 250 Next 250 500 15.5 Next 100 16.0 600 Next 250 16.5 Next 200 18.0 Next 200 21.0 What is the optimal capital budget (in millions) for Ajax? C $500 C $975 C $1,300 C $550

Answer 1

Solution:

As Ajax prioritizes projects according to their expected return rates, we can complete the table as follows in order of preference: (cumulative value is simply successively adding)

Ranking of expected return rate: 23 > 21 > 19 > 18 > 16 > 14 > 13, so preference goes the same way:

Project	Investment reqd	Expected return rate	Cumulative investment
A	500	23	500
C	50	21	500 + 50 = 550
G	250	19	550 + 250 = 800
B	175	18	800 + 175 = 975
D	125	16	975 + 125 = 1100
E	300	14	1100 + 300 = 1400
F	150	13	1400 + 150 = 1550

Similarly, we find cumulative values for the marginal costs:

Block of funds	Cost of capital	Cumulative fund raised
First 250	14	250
Next 250	15.5	250 + 250 = 500
Next 100	16	500 + 100 = 600
Next 250	16.5	600 + 250 = 850
Next 200	18	850 + 200 = 1050
Next 200	21	1050 + 200 = 1250

Optimal capital budget occurs where marginal cost of capita equals the marginal return from investing. Thus, Ajax's optimal budget would be (B) $975.