Question

24. CCC Company has access to the following capital amounts at the associated costs: $200k at

       6%, $200k at 8%, $400k at 9%, and $400k at 11%. Furthermore, the firm has the following

       after-tax investment opportunities: 1) project A, cost today - $400k, IRR 16%; 2) project B, cost

      today - $100k, IRR 14%;   3) project C, cost today $300k, IRR 13%;   4) project D, cost today   

       $200k, IRR 11%;   and 5) project E, cost today $200k, IRR 9%. (Projects must be accepted in

        totality.)

a) What is CCC’s optimal capital budget if the objective is to maximize profit before tax?

[Hint: Draw the IRR opportunity line vs. the marginal cost of capital (MCC) curve.]

Answer 1

The optimal capital budget can be detemined by plotting investment opportunity schedule and marginal cost of capital in one graph.

In the graph below, the point of intersection between IRR and MCC curve indicates that the company should undertake Project A, Project B, Project C and Project D as their IRR is greater than or equal to the marginal cost of capital. Project E should be rejected, as its IRR is less than the marginal cost of capital. Thus the optimal capital budget is $1 Million which is the sum of intial cost of project A,B,C and D. If the company undertakes these projects the profit before tax will be maximised.