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Optimal capital budget

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Taunton's target capital structure is as fallows.
Debt----------------------------30%
Preferred stock---------------5
Common equity--------------65
100%
Other information:
-Taunton's marginal tax rate (state and federal) is 40%
-Floatation cost average 12% for common stock
-Short term treasury bills currently yield 7.5%
-The market is returning 12.5%
-Taunton's beta is 1.2
-The firm is expected to grow at 6% indefinitely
-The last annual dividend paid was $1.00 per share
-Taunton expects to earn $ 5 million next year
-Taunton's common stock is selling for $12,50 per share
-Taunton's has 1,000,000 shares of common stock outstanding
-The cost of preferred stock is 12% percent
-The firm can borrow an additional $2 million at rates similar to the market return on its old debt, which is 10 percent. Beyond that, lenders are expected to demand returns in the neighborhood of 14%.
-Taunton has the following capital budgeting projects under consideration in the coming year. These represent its investment opportunity schedule (IOS).

Project IRR Capital Required Cumulative Capital Required
A 15% $3 million 3 million
B 14 2 million 25 million
C 13 2 million 7 million
D 12 2 million 9 million
E 11 2 million 11 million

Determine Taunton's optimal capital budget.

Solution Preview

Taunton's target capital structure is as fallows.
Debt----------------------------30%
Preferred stock---------------5
Common equity--------------65
100%
Other information:
-Taunton's marginal tax rate (state and federal) is 40%
-Floatation cost average 12% for common stock
-Short term treasury bills currently yield 7.5%
-The market is returning 12.5%
-Taunton's beta is 1.2
-The firm is expected to grow at 6% indefinitely
-The last annual dividend paid was $1.00 per share
-Taunton expects to earn $ 5 million next year
-Taunton's common stock is selling for $12.50 per share
-Taunton's has 1,000,000 shares of common stock outstanding
-The cost of preferred stock is 12% percent
-The firm can borrow an additional $2 million at rates similar to the market return on its old debt, which is 10 percent. Beyond that, lenders are expected to demand returns in the neighborhood of 14%.
-Taunton has the following capital budgeting projects ...

Solution Summary

The solution explains how to determine the optimal capital budget

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