Question

Ziege Systems is considering the following independent projects for the coming year:

Project	Required Investment	Rate of Return	Risk
A	$4 million	12.25%	High
B	5 million	14.75	High
C	3 million	10.25	Low
D	2 million	10.25	Average
E	6 million	13.25	High
F	5 million	13.25	Average
G	6 million	8.25	Low
H	3 million	12.75	Low

Ziege's WACC is 10.75%, but it adjusts for risk by adding 2% to the WACC for high-risk projects and subtracting 2% for low-risk projects.

1. Which projects should Ziege accept if it faces no capital constraints?

   Project A	-Select-AcceptRejectItem 1
   Project B	-Select-AcceptRejectItem 2
   Project C	-Select-AcceptRejectItem 3
   Project D	-Select-AcceptRejectItem 4
   Project E	-Select-AcceptRejectItem 5
   Project F	-Select-AcceptRejectItem 6
   Project G	-Select-AcceptRejectItem 7
   Project H	-Select-AcceptRejectItem 8

2. If Ziege can only invest a total of $13 million, which projects should it accept?

   Project A	-Select-AcceptRejectItem 9
   Project B	-Select-AcceptRejectItem 10
   Project C	-Select-AcceptRejectItem 11
   Project D	-Select-AcceptRejectItem 12
   Project E	-Select-AcceptRejectItem 13
   Project F	-Select-AcceptRejectItem 14
   Project G	-Select-AcceptRejectItem 15
   Project H	-Select-AcceptRejectItem 16

   If Ziege can only invest a total of $13 million, what would be the dollar size of its capital budget? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55.

   $    million

3. Suppose Ziege can raise additional funds beyond the $13 million, but each new increment (or partial increment) of $5 million of new capital will cause the WACC to increase by 1%. Assuming that Ziege uses the same method of risk adjustment, which projects should it now accept?

   Project A	-Select-AcceptRejectItem 18
   Project B	-Select-AcceptRejectItem 19
   Project C	-Select-AcceptRejectItem 20
   Project D	-Select-AcceptRejectItem 21
   Project E	-Select-AcceptRejectItem 22
   Project F	-Select-AcceptRejectItem 23
   Project G	-Select-AcceptRejectItem 24
   Project H	-Select-AcceptRejectItem 25

   What would be the dollar size of its capital budget? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55.

   $    million

Answer 1

Risk Project Required investment (S) Rate of return Risk Adjusted WACC (%) Reject if Net Profit ROR*WACC (ROR-WACC) Otherwise Accept Reject Accept Accept Reject Accept Accept Reject Accept 4 million 5 million 3 million 2 million 6 million 5 million 6 million 3 million 12.25 14.75 10.25 10.25 13.25 13.25 8.25 12.75 12.75 12.75 8.75 10.75 12.75 10.75 8.75 8.75 Low Average 0.5 Average Low Low 2.5 Ziege should accept Project: B, C, E, F and H. Ziege has total budget = $13 million so, project H. F and B should be accepted because project H. F and B has higher net profits than Project C and E Composition of investment of Project H, F and B is 3 million 5 million 5 million $13 million Hence, Size of Capital Budget- $13 million.