Question

Ziege Systems is considering the following independent projects for the coming year:

Project Required

Investment Rate of

Return Risk

A $4 million 12. 25% High

B 5 million 14. 75 High

C 3 million 10. 25 Low

D 2 million 10. 25 Average

E 6 million 13. 25 High

F 5 million 13. 25 Average

G 6 million 8. 25 Low

H 3 million 12. 75 Low

Ziege's WACC is 10. 75%, but it adjusts for risk by adding 2% to the WACC for high-risk projects and subtracting 2% for low-risk projects.

Which projects should Ziege accept if it faces no capital constraints?

Project A -Select-AcceptRejectItem 1

Project B -Select-AcceptRejectItem 2

Project C -Select-AcceptRejectItem 3

Project D -Select-AcceptRejectItem 4

Project E -Select-AcceptRejectItem 5

Project F -Select-AcceptRejectItem 6

Project G -Select-AcceptRejectItem 7

Project H -Select-AcceptRejectItem 8

If Ziege can only invest a total of $13 million, which projects should it accept?

Project A -Select-AcceptRejectItem 9

Project B -Select-AcceptRejectItem 10

Project C -Select-AcceptRejectItem 11

Project D -Select-AcceptRejectItem 12

Project E -Select-AcceptRejectItem 13

Project F -Select-AcceptRejectItem 14

Project G -Select-AcceptRejectItem 15

Project H -Select-AcceptRejectItem 16

If Ziege can only invest a total of $13 million, what would be the dollar size of its capital budget? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10. 55.

$ million

Answer 1

To determine which projects Ziege Systems should accept, we need to compare the projects' rates of return with the adjusted WACC based on their risk levels.

For high-risk projects, the adjusted WACC is 12.75% (10.75% + 2%), and for low-risk projects, the adjusted WACC is 8.75% (10.75% - 2%).

For projects A, B, E, and F, which are high-risk projects, we can calculate their adjusted net present values (NPVs) using the adjusted WACC of 12.75%:

• - Project A: NPV = -$4 million + ($4 million / (1 + 0.1275)^1) = -$3,518,519.58
• - Project B: NPV = -$5 million + ($5 million / (1 + 0.1475)^1) = -$4,319,651.17
• - Project E: NPV = -$6 million + ($6 million / (1 + 0.1325)^1) = -$5,266,343.57
• - Project F: NPV = -$5 million + ($5 million / (1 + 0.1325)^1) = -$4,578,004.12

For projects C, D, G, and H, which are low or average-risk projects, we can calculate their adjusted NPVs using the adjusted WACC of 8.75%:

• - Project C: NPV = -$3 million + ($3 million / (1 + 0.1025)^1) = $211,039.03
• - Project D: NPV = -$2 million + ($2 million / (1 + 0.1025)^1) = $851,739.13
• - Project G: NPV = -$6 million + ($6 million / (1 + 0.0825)^1) = $1,395,348.84
• - Project H: NPV = -$3 million + ($3 million / (1 + 0.1275)^1) = -$2,631,578.95

Based on these calculations, Ziege Systems should accept projects C, D, G, and H because they have positive adjusted NPVs. Projects A, B, E, and F should be rejected because they have negative adjusted NPVs.

If Ziege Systems can only invest a total of $13 million, it should select projects C, D, and H, which have a total required investment of $8 million and a total adjusted NPV of $431,200.16 ($211,039.03 + $851,739.13 - $2,631,578.95). Project G has a higher adjusted NPV, but it is more expensive than project H and would push the total investment over the budget constraint.

Therefore, the dollar size of Ziege Systems' capital budget would be $13 million.