Question

US Corp. is charged with determining which small projects should be funded. Along with this assignment, she has been granted the use of $15,000 for a maximum of two years. She is considering three projects. Project A costs $7,500 and has cash flows of $4,000 a year for Years 1 to 3. Project B costs $8,000 and has cash flows of $3,000, $4,000, and $3,000 for Years 1 to 3, respectively. Project C costs $2,000 and has a cash inflow of $2,500 in Year 2. What decisions should she make regarding these projects if she assigns them a mandatory discount rate of 8.5 percent

Answer 1

Answer:

• Project A and C given a budgetary constraint of $15,000.
• Pick all projects if there was not constraint as they all have positive NPVs.

Explanation:

Find the NPVs of the various projects.

Project A:

= Present value of inflows - Cost

= 4,000 / 1.085 + 4,000 / 1.085² + 4,000 / 1.085³ - 7,500

= $2,716.09

Project B:

= 3,000 / 1.085 + 4,000 / 1.085² + 3,000 / 1.085³ - 8,000

= $511.52

Project C:

= 2,500 / 1.085² - 2,000

= $123.64

Seeing as she has only $15,000 to embark on projects, she should pick projects A and C.

Project A should be picked because it has the highest NPV and Project C should be picked because it can still be invested in after Project A given budgetary constraints.