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In the table below
In the table below. the NPV, IRR. and Payback periods are already computed and given. You need to decide which project(s) to choose. The manager's goal is to maximize the firm value by an optimal allocation within the capital budget of $6 million. The required rate of return is 8%, for all projects.. If the projects are not mutually exclusive, which project(s) is (are) most likely to be accepted?
Project Initial Investment NPV Payback IRR W $1m $0.31m 5 years Undefined X $2m $0.36m 7 years 9% Y $3m $0.55m 6 years Undefined Z $3m $0.24m 6 years 9.8% .
0 0 OO 0
X, Y, and Z X and Y W. X, and Y
Expert Solution
First we calculate Profitability Index (PI):
Profitability Index (PI) = 1+NPV/Initial Investment
For W:
W=1+0.51/1=1.51
For X:
X=1+0.36/2=1.18
For Y:
Y=1+0.75/5=1.15
For Z:
Z=1+0.24/3=1.08
So, We choose from the highest Profitability Index till the budget is reached.
Choose W, X and Y.
Here, also a set of W, X and Y will generate highest positive NPV. So, it should be selected.
Hence, correct option is 3rd "W, X and Y".
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