Download Given the following graph

1.
Given the following graph:
%
25--
20--
15-MCC
10--
5 --IOS (IRR)
0
a.
I
I
I
I
2
4
6
8
I
10
I
12
I
I
14
16
I
18 $ in millions
What is the dollar amount of the optimal capital budget?
The optimal capital budget is where the IOS and MCC intersect. In the given graph, the intersection takes
place at $6 million and that is the optimal capital budget. This budget is optimal, since the projects beyond
this have an IRR of less than 10% and the cost of capital as given by the MCC is 10% and so these projects
cannot be accepted.
b.
What is the dollar amount of debt and equity to be used to finance the capital budget if D/A =
20%?
Given that Debt/Assets = 20%. The total investment in assets is 6 million. The amount of debt will be
6X20%= $1.2 million. The amount of equity will be $4.8 million.
c.
What is the dollar amount of new common stock to be sold associated with the optimal capital
budget?
From the graph, the change in the MCC takes place when the cost of any component of capital
changes. The starting MCC graph is from retained earnings and debt and then the change may happen
due to new equity or the cost of debt changing. Here the change in the MCC schedule happens at 8
million when new equity is used. The optimal capital budget is 6 million and so there is no need for
any new equity.
d.
Based on the residual theory, what should be the dollar amount of the total dividend?
In the residual theory, all net income is paid as dividends after meeting the capital requirements. Here
the requirement of equity is 4.8 million. The amount of dividends would be Net Income-4.8 million.
e.
What is the firm’s marginal cost of capital that is associated with the optimal capital budget?
From the MCC graph, the marginal cost of capital at optimal capital budget is 10%