OPTIMAL CAPITAL BUDGET Marble Construction estimates that its WACC is 10% if equity comes from

QUESTION

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 $2,500,000 of capital due to the number of highly profitable projects available to the firm and its limited earnings. The company is considering the following seven investment projects:ProjectSizeIRRA$ 650,00014.0%B1,050,00013.5C1,000,00011.2D1,200,00011.0E500,00010.7F650,00010.3G700,00010.2Assume that each of these projects is independent and that each is just as risky as the firms existing assets. Which set of projects should be accepted, and what is the firms optimal capital budget?
Optimal capital budget and project selection will be based on selection of combination of projects that willmaximize its annual return. Accordingly annual return calcualtion for given projects is as per below: Project Size IRR Annual return A 650000 14.00% 91,000.00 B 10,50,000 13.50% 1,41,750.00 C 10,00,000 11.20% 1,12,000.00 D 12,00,000 11.00% 1,32,000.00 E 5,00,000 10.70% 53,500.00 F 6,50,000 10.30% 66,950.00 G 7,00,000 10.20% 71,400.00 Combination of projects and annual reurn for the combination and capital budget outlay: Combination Annual return Capital outlay

et A,B,G 3,04,150.00 24,00,000 B,F,G 2,80,100.00 24,00,000 A,C,G 2,74,400.00 23,50,000 A,D,F 2,89,950.00 25,00,000 As we can see in above table that annual return is maximum under the combination of A,B,G projects. Accordingly project advised to selecta re A, B & G. Accordingly optimum capital budget will be 2400,000. Working note: Annual return = Capital investment (Size) * IRR

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