A firm is considering the following projects, all of which are independent of one another. Available funds are limited to $2 million in this capital budgeting period, but future periods will have no capital budget constraints.
Present Value of
Project Initial Outlay Cash Inflows
1 $1,300,000 $1,200,000
2 1,000,000 1,250,000
3 800,000 900,000
4 600,000 700,000
5 500,000 550,000
6 400,000 470,000
7 300,000 280,000
8 100,000 105,000
Which projects should be accepted without exceeding the budget?
Answer:
Project Profitability Index Cumulative Investment
2 1,250,000/1,000,000 = 1.25 $1,000,000
6 470,000/400,000 = 1.18 1,400,000
4 700,000/600,000 = 1.17 2,000,000
3 900,000/800,000 = 1.13 2,800,000
5 550,000/500,000 = 1.10 3,300,000
8 105,000/100,000 = 1.05 3,400,000
7 280,000/300,000 = 0.93 Reject
1 1,200,000/1,300,000 = 0.92 Reject
Projects 2, 6, and 4 should be accepted; they exhaust the budget.
