1 Why does WACC increase and IRR decrease as the capital bud

1. Why does WACC increase and IRR decrease as the capital budget increases? Are there any steps management can take to reverse these trends?

2. How should a company prioritize all of its capital project opportunities? In responding invoke the various methodologies learned this week and how to use them for ranking projects.

Solution

1.As the capital budget increases more capital is needed for investment either in the form of debt or equity. As a result Incremental cost of debt and equity is higher as the project becomes more risky with higher debt and cost of equity rises because the expectations of required return from equity by investors goes up. Since WACC is calculated from cost of debt and cost of equity and if both go up then overall WACC will go up
IRR decreases because IRR is a function of initial investment and if initial investment increases then IRR decreases. IRR is the rate at which NPV =0 . If the Cash flows does not increase in the same proportion the IRR will decrease

The above trend can be changed if cheaper sources of capital like preferred stock are used. By negotiating with the investors this cost can be brought down. Opting for an optimal debt equity and preferred stock ratio also will minimize WACC for higher investment. Using more retained earnings will reduce flotation and administration cost which will lower the WACC.
IRR can be increased by increasing the incremental cash flow which is generated. Better operational efficiency, use of proper depreciation policy and increasing sales can reverse the IRR.

As per Chegg Policy 1 question can be answered at a time. Please place the second question in Chegg again.
Best of luck. God Bless