Question

The Suboptimal Glass Company uses a process of capital rationing in its decision making. The firm’s cost of capital is 10 percent. It will only invest $57,800 this year. It has determined the internal rate of return for each of the following projects.

Project	Project Size			Internal Rate of Return
A	$	10,700			14	%
B		30,700			13
C		25,700			12
D		10,700			15
E		10,700			18
F		20,700			19
G		15,700			16

a. Pick out the projects that the firm should accept.

	Project A
	Project B
	Project G
	Project E
	Project F
	Project C
	Project D

b. If Projects E and F are mutually exclusive, which projects would you accept in spending the $57,800?

	Project A
	Project B
	Project G
	Project C
	Project F
	Project E
	Project D

Answer 1

a) Following projects should be picked for investment

Project F with cash outflow of $ 20,700 and IRR of 19%

Project E with cash outflow of $ 10,700 and IRR of 18%

Project G with cash outflow of $ 15,700 and IRR of 16%

Project D with cash outflow of $ 10,700 and IRR of 15%

Internal rate of return represents the expected growth rate of the project. Cost of capital refers to cost of financing the project. Project in order to be feasible has to match the cost of capital of the project.

Based on the Capital budget of $ 57,800 and cost of capital of 10%, company should pick above projects for investment

b) In case Project E and F are mutually exclusive, following projects should be picked up for spending of $ 57,800

Project F with cash outflow of $ 20,700 and IRR of 19%

Project A with cash outflow of $ 10,700 and IRR of 14%

Project G with cash outflow of $ 15,700 and IRR of 16%

Project D with cash outflow of $ 10,700 and IRR of 15%

In case of mutually exclusive projects, projects with higher Net Present Value or Internal Rate of Return should be picked up