Question

In: Finance

A firm must choose from six capital budgeting proposals outlined below. The firm is subject to...

  1. A firm must choose from six capital budgeting proposals outlined below. The firm is subject to capital rationing, has a capital budget of $1,000,000 and the firm’s cost of capital is 15 percent. Using the net present value approach to ranking projects, which projects should the firm accept?

Projects:

1

2

3

4

5

6

Initial Investment

$200,000

$400,000

$250,000

$200,000

$150,000

$400,000

IRR

14%

12%

10%

15%

12%

12%

NPV

$100,000

$20,000

$60,000

$(5,000)

$50,000

$150,000

  1. 1, 3, 5, and 6
  2. 1, 2, 3, 4, and 5
  3. 2, 3, 4, and 5
  4. 1, 3, 4, 5 and 6

Solutions

Expert Solution

Answer:1, 3, 5, and 6

We have 10,00,000 to invest.

Using the net present value approach to ranking projects, higher NPV shall accepted first, project with -ve NPV should be rejected. Hence reject project 4.

Here NPV based ranking is as follows

Ranking Project initial investment
1                           6                        4,00,000
2                           1                        2,00,000
3                           3                        2,50,000
4                           5                        1,50,000
                          5                           2                        4,00,000

Even though project 2 has +ve NPV we cant accept it as we had only 10 lakhs to invest.


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