The managers of United Medtronics are evaluating the following four projects for
ID: 2668070 • Letter: T
Question
The managers of United Medtronics are evaluating the following four projects for the coming budget period. The firms corporate cost of capital is 14 percent.
Project Cost IRR
A $ 15,000 17%
B 15,000 16
C 12,000 15
D 20,000 13
A.What is the firm's optimal capital budget?
b. Now, suppose Medtronic's managers want to consider differential risk in the capital budgeting process. Project A has average risk, B has below-average risk, C has above-average risk, and D has average risk.
What is the firm's optimal capital budget when differential risk is considered?
(Hint: The firm's managers lower the IRR of high-risk projects by 3 percentage points and raise the IRR of low-risk projects by the same amount.
Explanation / Answer
A All those projects where IRR> Cost of capital so A, B, C. $42,000. B. All those projects where adjusted IRR>Cost of capital so A and B only (C gets excluded because its risk adjusted IRR is 12. $30,000
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