Principles of Managerial Finance

494 PART 4 Long-Term Financial Decisions

c. Using the results of part balong with the information shown in the following

table on the available investment opportunities, draw the firm’s weighted

marginal cost of capital (WMCC) schedule and investment opportunities

schedule (IOS) on the same set of axes (total new financing or investment on

the xaxis and weighted average cost of capital and IRR on the yaxis).

d. Which, if any, of the available investments do you recommend that the firm

accept? Explain your answer. How much total new financing is required?

PROBLEMS

11 – 1 Concept of cost of capital Wren Manufacturing is in the process of analyzing

its investment decision-making procedures. The two projects evaluated by the

firm during the past month were projects 263 and 264. The basic variables sur-

rounding each project analysis, using the IRR decision technique, and the result-

ing decision actions are summarized in the following table.

a. Evaluate the firm’s decision-making procedures, and explain why the accep-

tance of project 263 and rejection of project 264 may not be in the owners’

best interest.

b. If the firm maintains a capital structure containing 40% debt and 60%

equity, find its weighted average cost using the data in the table.

Basic variables Project 263 Project 264

Cost $64,000 $58,000

Life 15 years 15 years

IRR 8% 15%

Least-cost financing

Source Debt Equity

Cost (after-tax) 7% 16%

Decision

Action Accept Reject

Reason 8% IRR7% cost 15% IRR16% cost

Internal

Investment rate of return Initial

opportunity (IRR) investment

A 11.2% $100,000

B 9.7 500,000

C 12.9 150,000

D 16.5 200,000

E 11.8 450,000

F 10.1 600,000

G 10.5 300,000

LG1