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IOS/MCCGraph

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Given the following graph:

%
25--

20--

15--
MCC

10--

5 ---
IOS (IRR)

I I I I I I I I I
0 2 4 6 8 10 12 14 16 18 $ in millions

a. What is the dollar amount of the optimal capital budget?

b. What is the dollar amount of debt and equity to be used to finance the capital budget if D/A = 20%?

c. What is the dollar amount of new common stock to be sold associated with the optimal capital budget?

d. Based on the residual theory, what should be the dollar amount of the total dividend?

e. What is the firm's marginal cost of capital that is associated with the optimal capital budget?

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The solution explains various questions relating to capital budgeting by using the IOS/MCC graph

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a. What is the dollar amount of the optimal capital budget?

The optimal capital budget is where the IOS and MCC intersect. In the given graph, the intersection takes place at $6 million and that is the optimal capital budget. This budget is optimal, since the projects beyond this have an IRR of less than 10% and the cost of capital as given by the MCC is 10% and so these projects cannot ...

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