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 zero,1,2,3,4,or 5 projects should be accepted.You have the following information:- r_RF = 4.00%; RP_M = 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.- 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, and C. The WACC for project A is 4.00% + (5.50% - 4.00%) * 1.00 * (-1%) = 3.95%. The WACC for project B is 4.00% + (5.50% - 4.00%) * 1.00 * (0%) = 4.00%. The WACC for project C is 4.00% + (5.50% - 4.00%) * 1.00 * (1%) = 4.05%. The NPV of project A is $25,000 * (1 - 1 / (1 + 0.0395)^10) / 0.0395 = $10,256. The NPV of project B is $25,000 * (1 - 1 / (1 + 0.04)^10) / 0.04 = $11,500. The NPV of project C is $25,000 * (1 - 1 / (1 + 0.0405)^10) / 0.0405 = $11,429. The total NPV of the three projects is $10,256 + $11,500 + $11,429 = $33,185. The company should accept projects A, B, and C because their total NPV is positive.

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