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Question - The managers of American Medtronics are evaluating the following four projects for the coming budget period. The firm's corporate cost of capital is 14 percent.
Project
Cost
IRR
A
$20,000
11%
B
$12,000
12%
C
$11,000
14%
D
$18,000
15%
a. What is the firm's optimal capital budget?
b. Now, suppose American Medtronic's managers want to consider differential risk in the capital budgeting process. Project A has average risk, B has below-average risk, C has above-average risk, and D has average risk. What is the firm's optimal capital budget when differential risk is considered? (Hint: The firm's managers lower the IRR of high-risk projects by 3 percentage points and raise the IRR of low-risk projects by the same amount.)
c. Return to the original assumption that all projects have average risk. If American Medtronics are only approved for $30,000 towards their project budget, which project or projects would you accept? (Hint: Any money not used for a project will not receive any return).
Use Excel in presenting the answers for your work. Be sure to show calculations (using cell formulas is suggested).
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