Question

Ajax corporation has the following set of projects available to it: All projects have equal risk.

Project	Investment Required (in Mil)	Expected Rate of Return (%)
A	500	23
B	75	18
C	50	21
D	125	16
E	300	14
F	150	13
G	250	19

Ajax can raise fuds with the following marginal costs:

First 250 Mil	14%
Next 250 Mil	15.5%
Next 100 Mil	16 %
Next 250 Mil	16.5%
Next 200 Mil	18%
Next 200 Mil	21%

Use the marginal cost and marginal revenue concepts to derive an optimal capital budget for Ajax.

Answer 1

Project F is eliminated because its IRR is less than the marginal cost. Also, Project E is eliminated because its IRR would be lower than the marginal cost given its investment size.

We select all the other projects with a total capital budget of $1,000.

From the first 250 mil, we finance Project G with IRR = 19% > 14%

From the next 250 mil, we finance Project B, C and D with IRR > 15.5%

We borrow additional 500 mil through which we finance Project A with IRR = 23% > highest cost of 18%

Optimal Capital Budget = 1000 to finance projects A, B, C, D and G.