3. CAPM and the optimal capital budget Ballack Inc. is a 100% equity-financed co

Question

3. CAPM and the optimal capital budget Ballack Inc. is a 100% equity-financed company (no debt or preferred stock); hence, its WACC equals Its cost of common equity. Ballack's retained earnings will be sufficient to fund Its capital budget In the foreseeable future. The company has a beta of 1.8, the risk-free rate is 5.0%, and the market risk premium I 5.0%. What is Ballack's WACC? 13.55% 13.70% 14.00% 13.80% 13.20% Ballack is considering the following projects for Investment next year: Each project has average risk, and Ballack accepts any project whose expected rate of return exceeds its cost of capital. How large should next year's capital budget be? $6,000 $5,000 $7,000 $4,000 $8,000

Explanation / Answer

Answer:

1. Cost of Equity = Risk free rate + Beta *Market risk premium

=5% +1.8 *5%

= 14%

Ballack’s WACC = Cost of Equity =14%

2. Ballack’s Required rate of return (WACC) is 14%, hence it shall accept the project which shall have return more than 14%, hence it will select Project X and Y.

Hence total Capital budget shall be = $2000+ $3000 =$5000

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