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Ques- a company has $100,000 avail for invest & has identified the foll 5 investments. All investments must be started now yr 0 Project C D E F
Initial investment (000) 40 100 50 60 50
NPV (000) 20 35 24 18 (10)
PI NPV/ 0.5 0.35 0.48 0.3 not worth while
REQUIRED- determine the optimal project selection
The solution is shown below (its from the KAPLAN text which is usually good but i don’t understand 1) how the 60% and 50% came about 2)(20+0.6 X 35) (24+0.5 X 35). Also I’m not seeing an eg on mutually exclusive in the OT notes.
SOLUTION:
MIX project C mix C, 60%D E, 50% D
Investment $ 100,000 100,000
NPV 41,000 41,500
(20+0.6 X 35) (24+0.5 X 35)i lined up everything perfectly in a horizontal manner but wen i posted it , the spaces changed. The question is in the kaplan text, its the last example in chapter 5 , Asset investment decisions and capital rationing. Your assistance would be very much appreciated.
Kaplans answer is not set out very nicely 🙂
All that mutually exclusive means is that you cannot do both C and E together (so if you do C then you cannot do E; if you do E then you cannot do C)
So….the choices are to do C in full (which costs 40), this leaves 60 which cannot be invested in E and so would be invested in D. Since D needs 100, it means doing 60% of D.
Alternatively, you could do E in full (which costs 50), this leaves 50 which cannot be invested in C and so would be invested in D. Since D needs 100, it means doing 50% of D.
So the choices are:
All of C, and 60% of D (which gives a total NPV of 41,000)
or
All of E, and 50% of D (which gives a total NPV of 41500)
Hope that helps 🙂
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