# Capital Budgeting

# 1. Stephenson & Sons has a capital structure that consists of 20 percent equity and 80 percent debt. The company expects to report $3 million in net income this year, and 60 percent of the net income will be paid out as dividends. How large must the firm's capital budget be this year without it having to issue any new common stock?

The answer is 6.00 Million. My caculations were off. Can you please explain how to get the answer step by step.

# 2. Dandy Product's overall weighted average required rate of return is 10 percent. Its yogurt division is riskier than average, its fresh produce division has average risk, and its institutional foods division has below-average risk. Dandy adjusts for both divisional and project risk by adding or subtracting 2 percentage points. Thus, the maximum adjustment is 4 percentage points. What is the risk?adjusted required rate of return for a low-risk project in the yogurt division?

The answer is 10%. My calculations didnt match this. Can you please explain how to get the answer step by step.

# 3. Project A has an IRR of 15 percent. Project B has an IRR of 18 percent. Both projects have the same risk. Which of the following statements is most correct?

The answer is "If the WACC is 15 percent, the NPV of Project B will exceed the NPV of Project A". I didnt even understand why this was the case. Can you please Explain.

THANK YOU VERY MUCH!

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#### Solution Preview

# 1. Stephenson & Sons has a capital structure that consists of 20 percent equity and 80 percent debt. The company expects to report $3 million in net income this year, and 60 percent of the net income will be paid out as dividends. How large must the firm's capital budget be this year without it having to issue any new common stock?

The answer is 6.00 Million. My caculations were off. Can you please explain how to get the answer step by step.

We start with the net income. Net Income is $3 million. 60% will be paid out as dividends, the remaining net income is 40% or $1.2 million. The capital structure is 20% equity and 80% debt. If this structure is to be maintained, then the capital budget should be funded by ...

#### Solution Summary

The solution has various problems in capital budgeting relating to calculation of amount of capital budget, required rate of return and NPV