Question

Hunt Company is considering 6 capital investment proposals for which the total funds available are limited to a maximum of $10 million. The projects are independent and have the following costs and profitability indexes. Under strict capital ration, which projects should be accept?

Project	Cost	Profitability Index
A	5,000,000	1.09
B	5,000,000	1.11
C	6,000,000	1.04
D	7,000,000	1.15
E	4,000,000	1.19
F	3,000,000	1.08

	a.	C and E
	b.	D and F
	c.	B and E
	d.	A and B

Answer 1

Option C. B & E

The projects that add maximum overall value should be selected. By value it means, projects couple that add maximum NPV is the answer.

By formula, Porfitability index:

And NPV = PV_{cash inflows} - PV_{cash outflows}

Therefore, NPV = (PI * PV_{cash outflows}) - PV_{cash outflows}

NPV = (PI - 1) PV_{cash outflows}

Now, let us calculate NPV for each of the project couples in options.

Projects C & E

NPV = (1.04 - 1) * 600000 + (1.19 - 1) * 4000000 = $1,000,000

Projects D & F

NPV = (1.15 - 1) * 700000 + (1.08 - 1) * 3000000 = $1,290,000

Projects B & E

NPV = (1.11 - 1) * 500000 + (1.19 - 1) * 4000000 = $1,310,000

Projects A & B

NPV = (1.09 - 1) * 500000 + (1.11 - 1) * 5000000 = $1,000,000

Hence, clearly, prject B & E should be chosen for they add maximum value.