You have a $10-million capital budget and must make the decision about which investments your firm should accept for the coming year. Projects 1, 2, and 3 are mutually exclusive, and Project 4 is independent of all three. The firm's cost of capital is 12 percent.
|
|
Project 1
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Project 2
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Project 3
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Project 4
|
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Initial cash outflow
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-$ 4,000,000
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-$ 5,000,000
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-$ 10,000,000
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-$ 5,000,000
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Year 1 cash inflow
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1,000,000
|
2,000,000
|
4,000,000
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2,700,000
|
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Year 2 cash inflow
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2,000,000
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3,000,000
|
6,000,000
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2,700,000
|
|
Year 3 cash inflow
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3,000,000
|
3,000,000
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5,000,000
|
2,700,000
|
a. Use the information on the three mutually exclusive projects to determine which of those three investments your firm should accept on the basis of NPV?
b. Which of the three mutually exclusive projects should the firm accept on the basis of PI?
c. If the three mutually exclusive projects are the only investments available, which one do you select?
d. Now given the availability of Project 4, the independent project, which of the mutually exclusive projects do you accept?
(Note: Remember, there is a $10 million budget constraint.) Is the better technique in this situation the NPV or the PI? Why?