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Determining the optimal capital budget

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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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 Summary

Solution determines the optimal capital budget in the given case.