Question

Vang Enterprises, which is debt-free and finances only with equity from retained earnings, is considering 7 equal-sized capital budgeting projects. Its CFO hired you to assist in deciding whether none, some, or all of the projects should be accepted. You have the following information: rRF= 4.50%; RPM = 5.50%; and b = 0.93. The company adds or subtracts a specified percentage to the corporate WACC when it evaluates projects that have above- or below-average risk. Data on the 7 projects are shown below. If these are the only projects under consideration, how large should the capital budget be?
Project Risk Risk Factor Expected Return Cost (Millions)
1 Very low -2.00% 7.60% $25.00
2 Low -1.00% 9.15% $25.00
3 Average 0.00% 10.10% $25.00
4 High 1.00% 10.40% $25.00
5 Very high 2.00% 10.80% $25.00
6 Very high 2.00% 10.90% $25.00
7 Very high 2.00% 13.00% $25.00

a. $ 125
b. $ 100
c. $ 25
d. $50
e. $75

Answer 1

Answer:

E $75

Explanation:

Using CAMP we solve for the Cost of equity on each and determinate which project are worht to invest on it

A

$Ke= r_f + \beta (r_m-r_f)$

risk free = 0.045

rate premium market = (market rate - risk free) =  0.055

beta(non diversifiable risk) = 0.93

$Ke= 0.045 + 0.93 (0.055)$

Ke 0.09615 = 9.615%

A 9.615% - 2.00% =  7.615% As the return is 7.60% we should reject

B 9.615% - 1% = 8.615% return of 9.15% we should Accept

C return of 10.10% while Ke 9.615% Accepted

D 9.615% + 1% = 10.615% return of 10.40% rejected

E 9.615% + 2% = 11.615% against 10.80% yield rejected

F cost of 11.615% ith return of 10.90% rejected

G cost of 11.615% with return of 13.00% Accepted

We accept three projectthus, we require $75