Problem 11A: Optimal Capital Budget: The management of Flannigan Phosphate Industries (FPI) is planning next year's capital budget. FPI projects its net income at $7,500, and its payout ratio is 40 percent. Depreciation is forecasted at $3,000. The company's earnings and dividends are growing at constant rate of 5 percent; the last Dividend, D0, was $0.90; and the current stock price is $8.59. FPI's new debt will cost 14 percent. If FPI issues new common stock, flotation casts will be 20 percent. FPI is at its optimal capital structure, which is 40 percent debt to 60 percent equity, and the firm's marginal tax rate is 40 percent. FPI has the following independent, indivisible, and equally risky investment opportunities:

Project

Cost

IRR

A

$15,000 17%

B

$20,000 14%

C

$15,000 16%

D

$12, 000 15%

What is FPI's optimal capital budget?

Problem 11B: Risk-Adjusted Optimal Capital Budget. Refer to Problem 12A. Management neglected to incorporate project risk differentials into the analysis. FPI's policy is to add 2 percentage points to the cost of capital of those projects significantly more risky than average and to subtract 2 percentage points from the cost of capital of those which are substantially less risky than average. Management judges Project A to be of high risk, Projects C and D to be of average risk, and Project B to be of low risk. No projects are divisible. What is the optimal capital budget after adjustment for project risk?