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Determining the optimal capital budget

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The managers of United Medtronic are evaluating the following four projects for the coming budget period. The firm's 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. Medtronic 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? (A 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.)

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Solution determines the optimal capital budget in the given case.

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a. What is the firm's optimal capital budget?
IRRs of projects A, B, and C are above cost of capital i.e. 14%, these should be selected.
Optimal capital budget=Cost of project A+ Cost of project B+ Cost of project C
= ...

Solution provided by:
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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