Question

6. A firm faces the issue of which investments to undertake. There are three projects, A, B, and C, each with a horizon (duration) of 8 years. For each of the three projects, financial management has already computed the decision-relevant measures of profitability as depicted in the table below. These computations already incorporate issues such as taxes and inflation. There is no risk or uncertainty involved and the projects’ returns are independent.

Project	Initial Investment	PV of Future Cash Flows	NPV	MIRR	PB	DPB
A	35,000	38,000	3,000	13.16%	3.5	3.8
B	65,000	72,500	7,500	13.54%	2.3	3.2
C	20,000	22,000	2,000	13.34%	5.5	7.12

0. For each of the following scenarios, derive and explain which project should be implemented, and what the overall attainable NPV for the firm is.

   1. (a) Projects are mutually exclusive, not scalable, and there are no capital constraints.

   2. (b) Projects are not mutually exclusive, not scalable, and the firm can raise at most £80′000 in capital to finance initial investments.

   3. (c) Projects are not mutually exclusive, but are arbitrarily scalable, and the firm can raise at most £100′000 in capital to finance initial investments.

Answer 1

a)	Project B with the highest NPV should be implemented.
	Total NPV = GBP7500
b)	Here, combination of projects yielding highest total
	NPV but having total initial investment within GBP 80000
	are to be selected.
	Project B with the highest NPV should be implemented.
	The total NPV = GBP7500.
	Other alternatives:
	Project B cannot be combined with any other project
	as the total investment would go over 80000 GBP.
	A & C together will give NPV of 5000 GBP only.
c)	Here, PI of projects would be used as the investments are
	scalable.
	Project	PI
	A	1.09
	B	1.12
	C	1.10
	As Project B has the highest PI, it would be implemented in full.
	Project C has the next highest PI. It will also be implemented
	in full.
	The balance of capital fund left would be 100000-85000=15000.
	Project A would be scaled down to GBP15000 with NPV of
	3000*15000/35000 = GBP 1286.
	Total NPV = 1286+7500+2000 =		GBP 10786