Question

Ford Allen, CEO of the Amstelveen Corporation, has some major decisions to make. Seven division managers are clamoring for investment in projects totaling €34,000,000. Allen is working to fund them all, but currently only has €8,000,000 available for Amstelveen to invest.

Proposals (all amounts in € thousands)
	Project	A	B	C	D	E	F	G
Initial Investment		1,000	2,000	8,000	5,000	5,000	10,000	3,000
Annual cash flows	Year 1	500	1,500	2,000	4,800	2,000	3,000	1,500
	Year 2	1,000	1,000	2,000	1,000	3,000	2,000	1,200
	Year 3	500	300	8,000	6,000	5,000	1,500	400
	Year 4	1,000	500	2,000	-3,000	1,000	2,000
	Year 5	1,500	200	2,500	-4,000	3,000	3,000

Amstelveen’s cost of capital is 7%, it uses a payback period cut-off of 2 years, and it calculates depreciation on a straight-line basis with the assumption of a zero salvage value. Allen has tasked you, an employee in the corporate controller’s office, with several tasks.

First, if there are no capital constraints, identify each project as advisable or inadvisable to pursue. Calculate this using the four methods of calculating capital budgeting that we covered in class. If there are any contradictory recommendations (i.e., recommended under payback but not recommended under IRR), explain how this is possible and what you would recommend as the dominant criteria.

Second, give the recommended total that you suggest Amstelveen raise, in addition to the €8,000,000 it already has, in order to invest in your recommended projects.

Third, Allen wants a recommendation on which project(s) the company should pursue if it remains limited to €8,000,000. Make sure to clearly explain the basis for your recommendation.

Note: you cannot recommend abandoning Project D when it becomes negative in Year 4.

Answer 1

	Present Value (PV) of Cash Flow:
	(Cash Flow)/((1+i)^N)
	i=Discount Rate=Cost of Capital=7%=0.07
	N=Year of Cash Flow
		PROJECT A
		N	A	B	PV=A/(1.07^N)
		Year	Cash Flow	Cumulative Cash Flow	Present Value of Cah Flow
		0	-1,000	-1,000	-1,000
		1	500	-500	467.29
		2	1000	500	873.44
		3	500	1,000	408.15
		4	1000	2,000	762.90
		5	1500	3,500	1069.48
				SUM	2,581
	Payback Period=Period at which Cumulative Cash Flow=Zero
	Payback Period=(1+(500/1000))=	1.5	Years
	Net Present Value(NPV)	2,581
	Internal Rate of Return(IRR)	67.6%
	Profitability Index=(PI)=(NPV+InitialCost)/(Initial Cost)
	Profitability Index=PI=(2581+1000)/(1000)	3.581251868
	ADVISABLE
	PROJECT	A	B	C	D	E	F	G
	RECOMMENDATION	ADVISABLE	ADVISABLE	ADVISABLE	NOT ADVISABLE	ADVISABLE	NOT ADVISABLE	NOT ADVISABLE
	PAYBACK(Years)	1.5	1.5	2.5	1.2	2	4.5	2.75
	NPV	2581.25	1044.24	5454.68	116.58	6472.82	-560.19	-223.49
	IRR	67.65%	34.09%	28.41%	3.49%	46.68%	4.86%	2.0%
	PI	3.58	1.522121046	1.6818344	1.023315389	2.29456364	0.943981155	0.925504928
	INVETMENT REQUIRED	1,000,000	2,000,000	8,000,000		5,000,000
	Total Investment Required for advisable Projects	16,000,000	(1+2+8+5)million
	Additional amount Required=(16-8)million	8,000,000
	Projects to be Selected within 8million constraint
	PROJECT	NPV	Investment	Cumulative
	E	6472.82	5,000,000	5,000,000
	C	5454.68	Not choen
	A	2581.25	1,000,000	6,000,000
	B	1044.24	2,000,000	8,000,000