Rhonda Pollak Company is considering three investments whose initial costs and internal rates of return are given below:
|
Project
|
Initial Cost ($)
|
Internal Rate of Return (%)
|
|
A
|
100,000
|
19
|
|
B
|
125,000
|
15
|
|
C
|
225,000
|
12
|
The company finances all expansion with 40 percent debt and 60 percent equity capital. The after-tax cost is 8 percent for the first $100,000, after which the cost will be 10 percent. Retained earnings in the amount of $150,000 is available, and the common stockholders' required rate of return is 18 percent. If the new stock is issued, the cost will be 22 percent. Calculate (a) the dollar amounts at which breaks occur, and (b) calculate the weighted cost of capital in each of the intervals between the breaks. (c) Graph the firm's weighted marginal cost of capital (MCC) schedule and investment opportunities schedule (IOS). (d ) Decide which projects should be selected and calculate the total amount of the optimal capital budget.