Durst Enterprises, which is debt-free and finances only with equity from retained earnings, is considering five large capital budgeting projects. Its CFO hired you to assist in deciding whether none, one, two, three, four, or five projects should be accepted. You have the following information: - rRF = 4.00%; RPM = 5.50%; and b = 1.00.
- The company adds 5%, 3%, 1%, 0%, or -1% to the corporate WACC when it evaluates projects that differ in risk.
- Project A is in the -1% category, B is in the 0% group, C is in the +1% group, D is in the +3%
Group, and E is in the most risky +5% group.
- Each project has a cost of $25,000. (5) The projects' expected returns are as follows: A = 8.7%, B =
9)60%, C = 10.30%, D = 13.80%, and E = 14.70%. If these are the only projects under consideration, how large should Durst's capital budget be?

Question

Quizplus · Accepted Answer

The correct answer is A because the company should accept projects A, B, C, and D. The WACC for each project is as follows: A = 4.00% - 1% = 3.00%, B = 4.00% + 0% = 4.00%, C = 4.00% + 1% = 5.00%, D = 4.00% + 3% = 7.00%, and E = 4.00% + 5% = 9.00%. The NPV of each project is as follows: A = $25,000 * (1 - 1 / (1 + 0.03)^10) / 0.03 * (1 + 0.03) = $18,128.64, B = $25,000 * (1 - 1 / (1 + 0.04)^10) / 0.04 * (1 + 0.04) = $17,832.65, C = $25,000 * (1 - 1 / (1 + 0.05)^10) / 0.05 * (1 + 0.05) = $17,548.97, D = $25,000 * (1 - 1 / (1 + 0.07)^10) / 0.07 * (1 + 0.07) = $17,029.85, and E = $25,000 * (1 - 1 / (1 + 0.09)^10) / 0.09 * (1 + 0.09) = $16,386.29. The total NPV of the four projects is $18,128.64 + $17,832.65 + $17,548.97 + $17,029.85 = $70,539.11. The company should therefore accept projects A, B, C, and D, which have a total cost of $100,000.

Durst Enterprises, Which Is Debt-Free and Finances Only with Equity