Answer:
Please refer below the answer in detail
Explanation:
a)
With a limited budget, the firm will first pursue projects with the highest return, and the allocate the remaining capital to the project with the second highest return, and so on until all capital is fully allocated. Based on the information, Project 6 has the highest return, followed by 1 and 3. These three projects together will cost:
350,000 + 300,000 + 250,000 = $900,000
After those three projects, the firm will have $100,000 left. The best out of remaining project is 7, but it costs 400,000, which the firm cannot afford. The best affordable project is 4, which offers a return of 12.1%. Hence, the firm should spend the remaining 100,000 on project 4.
b)
The budget limit constraints the firm to give up project 7, which offers a NPV of $48,000. The firm is forced to choose project 4, which has a NPV of $14,000.
Thus the lost in market value of the firm = 48,000 - 14,000 = $34,000.
