Final answer:
Projects B and C should definitely be accepted as their expected rates of return exceed the cost of equity of 13.05%. Project D's return is very close to the cost of equity and may be accepted based on the company's threshold for acceptance. This results in a capital budget size of either $9,825 (excluding D) or $13,500 (including D).
Step-by-step explanation:
Hack Wellington Co. is considering which projects to accept based on a comparison between the expected rate of return for each project and the company's cost of equity. The company's cost of equity is 13.05%, and it accepts any project where the expected rate of return exceeds this cost. In analyzing the given projects:
- Project A has an expected rate of return of 10.60%, which is lower than the cost of equity, and therefore should not be accepted.
- Project B has an expected rate of return of 13.65%, which is higher than the cost of equity, and therefore should be accepted.
- Project C has an expected rate of return of 14.10%, which is higher than the cost of equity, and therefore should be accepted.
- Project D has an expected rate of return of 13.10%, which is nearly equal to the cost of equity, and might be accepted depending on the company's acceptance threshold for rate of return just meeting the cost of equity.
By this criterion, Projects B ($6,375) and C ($4,575) should definitely be included in next year's capital budget. If Project D is accepted, it would also add $3,675. Therefore, depending on the company's policy regarding projects with a rate of return nearly equal to the cost of equity, the size of next year's capital budget should be $9,825 (excluding Project D) or $13,500 (including Project D).