Question

The Suboptimal Glass Company uses a process of capital rationing in its decision making. The firm’s cost of capital is 10 percent. It will only invest $68,000 this year. It has determined the internal rate of return for each of the following projects.

Project	Project Size			Internal Rate of Return
A	$	12,000			11	%
B		17,000			13
C		27,000			16
D		12,000			15
E		12,000			19
F		22,000			12
G		17,000			17

a. Pick out the projects that the firm should accept. (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)

b. If Projects E and G are mutually exclusive, which projects would you accept in spending the $68,000? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)

Answer 1

we should rank the investments in terms of IRR, this results in the following ranking:

Project	IRR	Project Size	Total Budget
E	19%	$12,000	$12,000
G	17%	$17,000	$29,000
C	16%	$27,000	$56,000
D	15%	$12,000	$68,000
B	13%	$17,000	$85,000
F	12%	$22,000	$107,000
A	11%	$12,000	$119,000

a) Because of capital rationing, only $68,000 worth of projects can be accepted. The four projects to accept are E,G,C and D. Projects B and F provide benefits but cannot be undertaken under capital rationing.

b) If projects E and G are mutually exclusive, you would select the project E in preference to G. You would then include project B with the freed up funds. In summary, you would accept E, C, D and B.