A firm must choose from six capital budgeting proposals outlined below. The firm is subject to...

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Finance

A firm must choose from six capital budgeting proposalsoutlined below. The firm is subject to capital rationing, has acapital budget of $1,000,000 and the firm’s cost of capital is 15percent. Using the net present value approach to ranking projects,which projects should the firm accept?
Projects:
1
2
3
4
5
6
Initial Investment
$200,000
$400,000
$250,000
$200,000
$150,000
$400,000
IRR
14%
12%
10%
15%
12%
12%
NPV
$100,000
$20,000
$60,000
$(5,000)
$50,000
$150,000
1, 3, 5, and 6
1, 2, 3, 4, and 5
2, 3, 4, and 5
1, 3, 4, 5 and 6

Answer & Explanation Solved by verified expert

3.7 Ratings (329 Votes)

Answer:1, 3, 5, and 6

We have 10,00,000 to invest.

Using the net present value approach to ranking projects, higher NPV shall accepted first, project with -ve NPV should be rejected. Hence reject project 4.

Here NPV based ranking is as follows

Ranking	Project	initial investment
1	6	4,00,000
2	1	2,00,000
3	3	2,50,000
4	5	1,50,000
5	2	4,00,000

Even though project 2 has +ve NPV we cant accept it as we had only 10 lakhs to invest.

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Transcribed Image Text

A firm must choose from six capital budgeting proposalsoutlined below. The firm is subject to capital rationing, has acapital budget of $1,000,000 and the firm’s cost of capital is 15percent. Using the net present value approach to ranking projects,which projects should the firm accept?Projects:123456Initial Investment$200,000$400,000$250,000$200,000$150,000$400,000IRR14%12%10%15%12%12%NPV$100,000$20,000$60,000$(5,000)$50,000$150,0001, 3, 5, and 61, 2, 3, 4, and 52, 3, 4, and 51, 3, 4, 5 and 6

Projects:	1	2	3	4	5	6
Initial Investment	$200,000	$400,000	$250,000	$200,000	$150,000	$400,000
IRR	14%	12%	10%	15%	12%	12%
NPV	$100,000	$20,000	$60,000	$(5,000)	$50,000	$150,000