Five separate projects have calculated rates of return of8,11,12.4,14, and 19% p
ID: 2662265 • Letter: F
Question
Five separate projects have calculated rates of return of8,11,12.4,14, and 19% per year. An engineer wants to know whichprojects to accept on the basis of rate of return. She learns fromthe finance department that company funds, which have a cost ofcapital of 18% per year, are commonly used to fund 25% of allcapital projects. Later, she is told that borrowed money iscurrently costing 10%per year. If MARR is established at exactlythe weighted average cost of capital, which projects should sheaccept?would it just be 19% per year?
Five separate projects have calculated rates of return of8,11,12.4,14, and 19% per year. An engineer wants to know whichprojects to accept on the basis of rate of return. She learns fromthe finance department that company funds, which have a cost ofcapital of 18% per year, are commonly used to fund 25% of allcapital projects. Later, she is told that borrowed money iscurrently costing 10%per year. If MARR is established at exactlythe weighted average cost of capital, which projects should sheaccept?
would it just be 19% per year?
Explanation / Answer
MARR is Minimum Attractive Rate of return. As per the stt above, the firms' cost of borrowing is now revisedto 10% pa from initial 18% pa. WACC = Weighted avge cost of capital = (E/(D+E) * Re) + (D/(D+E) *Rd)(1 - t) E = Market value of the firm's equity D = Market value of the firm's debt Re = Cost of equity Rd = Cost of debt T = corporate tax rate (typically 35%) Thus the Engineer can accept any of the above 5 projects whose Rateof Return is more than MARR which is 10%. Thus in order of preference, the engineer should accept 19%, 14%,12.4%, 11% and reject 8% MARR project
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