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	5,000	8,000	5,000	10,000	3,000
Annual cash flows	Year 1	500	1,500	4,800	2,000	2,000	3,000	1,500
	Year 2	1,000	1,000	1,000	2,000	3,000	2,000	1,200
	Year 3	500	300	6,000	8,000	5,000	1,500	400
	Year 4	1,000	500	-3,000	2,000	1,000	2,000
	Year 5	1,500	200	-4,000	2,500	3,000	3,000

Amstelveen’s cost of capital is 6.25%, 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 three methods of calculating capital budgeting that we covered in class (not ARR, we did not do any math with that method). 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 C when it becomes negative in Year 4.

Answer 1

Answer
		A	B	C	D	E	F
	Initial Investment (a)	1000	2000	5000	8000	5000	10000
	Annual cash flows	469	1408	4507	1878	1878	2817
	Year 2	882	882	882	1763	2645	1763
	Year 3	414	248	4967	6623	4139	1242
	Year 4	777	389	-2332	1555	777	1555
	Year 5	1095	146	-2920	1825	2190	2190
	Cash Inflow (b)	3637	3073	5104	13643	11629	9566
	Net Cash Inflow (b-a)	2637	1073	104	5643	6629	-434
	Cash Flow Index (b/a)	3.64	1.54	1.02	1.71	2.33	0.96
	Rank	I	IV	V	III	II	Negative Cash Flow
First	IF No Capital Constraints then following project will be selected as its Ranking
		A	B	C	D	E	F
	Rank	I	IV	V	III	II	Negative Cash Flow
	Project	Capital Investment required
		(thousands $)
	A	1000
	E	5000
	D	8000
	B	2000
	C	5000
		21000
Second	If only Capital Constraints is there and only 8000 Thousands dollar to invest then following project will be use get highest cash inflow
	Project	Capital Investment required
		(thousands $)
	A	1000
	E	5000
	D	2000	Only 2000 Thousand dollar remaining to invest
		8000