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: r_RF = 4.50%;RP_M = 5.50%;and b = 0.98.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? $\begin{array} { l l l l l } \text { Project } & \text { Risk } & \text { Risk factor } & \begin{array} { l } \text { Expected } \\\text { return }\end{array} & \text { Cost (millions) } \\\hline 1 & \text { Very low } & - 2.00 \% & 7.60 \% & \$ 25 \\2 & \text { Low } & - 1.00 \% & 9.15 \% & \$ 25 \\3 & \text { Average } & 0.00 \% & 10.10 \% & \$ 25 \\4 & \text { High } & 1.00 \% & 10.40 \% & \$ 25 \\5 & \text { Very high } & 2.00 \% & 10.80 \% & \$ 25 \\6 & \text { Very high } & 2.00 \% & 10.90 \% & \$ 25 \\7 & \text { Very high } & 2.00 \% & 13.00 \% & \$ 25\end{array}$
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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: r_RF = 4.50%;RP_M = 5.50%;and b = 0.98.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?

\begin{array} { l l l l l } \text { Project } & \text { Risk } & \text { Risk factor } & \begin{array} { l } \text { Expected } \\\text { return }\end{array} & \text { Cost (millions) } \\\hline 1 & \text { Very low } & - 2.00 \% & 7.60 \% & \$ 25 \\2 & \text { Low } & - 1.00 \% & 9.15 \% & \$ 25 \\3 & \text { Average } & 0.00 \% & 10.10 \% & \$ 25 \\4 & \text { High } & 1.00 \% & 10.40 \% & \$ 25 \\5 & \text { Very high } & 2.00 \% & 10.80 \% & \$ 25 \\6 & \text { Very high } & 2.00 \% & 10.90 \% & \$ 25 \\7 & \text { Very high } & 2.00 \% & 13.00 \% & \$ 25\end{array}

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Quizplus · Accepted Answer

The capital budget should be $75 million, which includes the costs of projects 3, 6, and 7. These projects have expected returns of 10.10%, 10.90%, and 13.00% respectively, which are above the corporate WACC of 10.10% (4.50% + 5.50%). Projects with expected returns higher than the WACC should be accepted.

Vang Enterprises,which Is Debt-Free and Finances Only with Equity from Retained