Question

A firm utilizes a strategy of capital rationing, which is currently $375,000 and is considering the following two projects: Project A has a cost of $335,000 and the following cash flows: year 1 $140,000; year 2 $150,000; and year 3 $100,000. Project B has a cost of $365,000 and the following cash flows: year 1 $220,000; year 2 $110,000; and year 3 $150,000. Using a 6% cost of capital, which decision should the financial manager make?

Select project A.

Select project B.

Do not select either project.

Select both projects.

Answer 1

Calculation of net cash inflow from both project
Particular	Present value of $1 @ 6%	Project A			Project B
		Cash Inflow	Present value of Cash Inflow		Cash Inflow	Present value of Cash Inflow
		($)	($)		($)	($)
Year 1	0.943	1,40,000	1,32,020		2,20,000	2,07,460
Year 2	0.89	1,50,000	1,33,500		1,10,000	97,900
Year 3	0.84	1,00,000	84,000		1,50,000	1,26,000
Total			3,49,520			4,31,360
Less: Initial Investment			3,35,000			3,65,000
Net Present value			14,520			66,360
* Firm strategy of total capital rationing is $375000. It can not opt both project , firm can consider only one project from above two.
* Since Net present value of project B is higher i.e.$ 66,360 ,so Firm should opt project B