Capital rationing—NPV approach A firm with a 13% cost of capital must select the
ID: 2716372 • Letter: C
Question
Capital rationing—NPV approach A firm with a 13% cost of capital must select the optimal group of projects from those shown in the following table, given its capital budget of $1 million.
NPV at 13%
Project
Initial investment
cost of capital
A
$300,000
$ 84,000
B
200,000
10,000
C
100,000
25,000
D
900,000
90,000
E
500,000
70,000
F
100,000
50,000
G
800,000
160,000
a. Calculate the present value of cash inflows associated with each project.
b. Select the optimal group of projects, keeping in mind that unused funds are costly.
NPV at 13%
Project
Initial investment
cost of capital
A
$300,000
$ 84,000
B
200,000
10,000
C
100,000
25,000
D
900,000
90,000
E
500,000
70,000
F
100,000
50,000
G
800,000
160,000
Explanation / Answer
(a) Present value of cash inflows associated with each project is NPV of the project at 13% cost of capital. which is already given in the question
(b)Select the combination of projects which will yield highest return without exceeding $1 million.:
4 projects with higher yields:
However we have to invest only 1million 1000000, therefore Project A,F, G should be selected.
Project Present Value of Cash Inflows A $84,000 B 10,000 C 25,000 D 90,000 E 70,000 F 50,000 G 160,000