Moussawi Enterprises, which finances only with equity from retained earnings, is considering two large capital budgeting projects, and its CFO hired you to assist in deciding whether one, both, or neither of the projects should be accepted. You have the following information: (1) rRF = 5.5%; RPM = 6%; and b = 0.8. (2) The company adds 3% to the corporate WACC when it evaluates relatively risky projects, and it deducts 1% from the WACC when evaluating relatively safe projects. (3) Project S is relatively safe, it costs $10,000, and its expected rate of return is 8%, while Project R is relatively risky, it costs $15,000, and its expected rate of return is 12%. If these are the only two projects under consideration, how large should the capital budget be?
The answer is $15,000, please, help me to find the way to proceed.
These are the calculations I've made:
| beta |
0,8 |
|
| rRF |
5,50% |
|
| RPM |
6,00% |
|
| r=rRF+b(RPM) |
10,30% |
|
| WACC=r |
|
|
| |
Project 1 |
Project 2 |
| safe/risky |
-1,00% |
3,00% |
| cost |
$10 000,00 |
$15 000,00 |
| r |
8,00% |
12,00% |
| WACC |
9,30% |
13,30% |