The Costa Coffee Company (For short Costa) is anticipating a major expansion of its franchised coffee outlets into Europe and African countries. The investment opportunities available to the company involve rates of return and initial investment amounts that differ because of differences in operating costs and consumer demand in the countries involved. The total investment (Z) that Costa can undertake is constrained by the cost of capital (K), which is defined by the following function:

K = 6 + 0.8 Z

The initial investment and rate of return (or the IRR) for each country are listed below in order of decreasing rate of return.

Country

Initial Investment (Z)

($ millions)

Rate of Return (IRR) (%)

South Africa

3.8

16.0

Kenya

1.3

15.0

France

2.4

13.0

Germany

3.1

11.0

Ethiopia

1.9

9.0

(A) Plot the investment marginal cost of capital (MCC or WACC, we also call it the supply curve) and the investment demand curve (or the IRR curve) on the graph below. (Hint: note that you have to cumulate the values of Z on the horizontal axis).

(B)Determine the optimal level of investment and the corresponding cost of capital for the firm.