Question

Four projects P, Q, R and S, are available to a company which is facing shortages of capital over the next years but expects capital to be freely available thereafter.

	P ‘000 €	Q '000 €	R ‘000 €	S ‘000 €
Total capital required over life of project	20	30	40	50
Capital required in next year	20	10	30	40
Net present value (NPV) of project at company’s cost of capital	60	40	80	80

In what sequence should the projects be selected if the company wishes to maximise net present values?

Answer 1

If the company want to maximise the Net Present value following scenario has be analysed:
	P	Q	R	S
Capital Required next year	€ 20,000	€ 10,000	€ 30,000	€ 40,000
NPV of the project at the company cost of capital	€ 60,000	€ 40,000	€ 80,000	€ 80,000
Total capital required	€ 20,000	€ 30,000	€ 40,000	€ 50,000
Cash Inflow from each project	€ 80,000	€ 70,000	€ 1,20,000	€ 1,30,000
(NPV + Total capital required)
Times of NPV against total capital required(NPV/Total capital required)	3	1.33	2	1.60
Ranking	1st	4th	2nd	3rd
Product P, R , S and then E
Capital should be invested according to the ranking as they will earn a maximum NPV because project ultimately has to be evaluated on the basis overall capital invested and NPV achieved from it .
Notes
Assuming that NPV given in the question is calculated on the overall project cost and not just on the basis of Next year capital requirement
We have to see the that which project generate maximum NPV with less capital irrespective of the fact that shortage of capital is there in next year because maximization of NPV is achieved on basis of total capital required for that project.