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solution

The managers of United Medtronics are evaluating the following four projects for the coming budget period. The firm’s corporate cost of capital is 14 percent.

a. What is the firm’s optimal capital budget?

b. Now, suppose Medtronics’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.)

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