1. Over-the-Top Canopies (OTC) is evaluating two independent investments. Project S costs $150,000 and has an IRR equal to 12 percent, and Project L costs $140,000 and has an IRR equal to 10 percent. OTC's capital structure consists of 20 percent debt and 80 percent common equi- ty, and its component costs of capital are rdT 5 4%, rs 5 10%, and re 5 12.5%. If OTC expects to generate $230,000 in retained earnings this year, which project(s) should be purchased?
2. Tri-Q Supply Company is considering an expansion project to increase sales. The project, which costs $2.6 million, has an IRR equal to 9.2 percent. Any portion of the project can be purchased. Tri-Q expects to retain $1.3 million of earnings this year. It can raise up to $420,000 in new debt with a before-tax cost equal to 5 per- cent; any additional debt will cost 7 percent before taxes. Tri-Q's cost of retained earnings is 12 percent, and its cost of new common equity is 14 percent. Its target capital structure consists of 35 percent debt and 65 percent common equity. If Tri-Q's marginal tax rate is 40 percent, what is the optimal capital budget?