Question

You have a $10 million capital budget and must make the decision about which investments your firm should accept for the coming year. The firm’s cost of capital is 12 percent. Use the information on the four projects to determine what project(s) your firm should accept on the basis of NPV?

	Project 1	Project 2	Project 3	Project 4
Initial CF	-4,000,000	-5,000,000	-10,000,000	5,000,000
Year 1 CF	1,000,000	2,000,000	4,000,000	2,700,000
Year 2 CF	2,000,000	3,000,000	6,000,000	2,700,000
Year 3 CF	3,000,000	3,000,000	5,000,000	2,700,000

A) Projects 3, 4

B) Projects 1, 2

C) Project 3

D) Projects 2, 4

Answer 1

First let us calculate the NPV of project 1:

($4,000,000) + $1,000,000/1.12 + $2,000,000/1.12^2 + $3,000,00/1.12^3

The NPV is : $622,585.6414

Similarly , the NPV of Project 2:

= $13,12636.662

Similarly ,the NPV of project 3 is :

= $21913,493.08

Similarly , the NPV of project 4 is :

= $11,484,944.42

The highest NPV is Project 3 and since this project meets the requirements of the investment amount, so the project 3 should be chosen.

So, the correct option is option C.