Use the following information to answer next three questions: IO PI IRR LIFEProject 1 $300,

Use the following information to answer next three questions: IO PI IRR LIFEProject 1 $300,000 1.12 14.38% 15 yearsProject 2 $150,000 1.08 13.32% 6 yearsProject 3 $100,000 1.20 16.46% 3 yearsAssume that the cost of capital is 12%.If the firm has a maximum capital expenditures budget of $450,000, and if the projects are independent and mutually exclusive but not repeatable, which project(s) should be accepted?Projects 1 and 2Projects 1 and 3Projects 2 and 3Projects 1, 2, and 3Project 1

0 thoughts on “Use the following information to answer next three questions: IO PI IRR LIFEProject 1 $300,”

  1. Answer:

    Project 1

    Explanation:

                        IO          PI    IRR       LIFE

    Project 1 $300,000 1.12 14.38% 15 years

    Project 2 $150,000 1.08 13.32% 6 years

    Project 3 $100,000 1.20 16.46% 3 years

    Assume that the cost of capital is 12%.

    We should invest in  the projects that have the highest profitability index (PI) first.

    PI = present value of project’s cash flows / initial outlay

    Projects with a high PI should also have high IRRs and this applies to this situation:

    1. Project 3 has a PI of 1.2 and an IRR of 16.46%
    2. Project 1 has a PI of 1.12 and an IRR of 14.38%
    3. Project 2 has a PI of 1.08 and an IRR of 13.32%

    If the protects weren’t mutually exclusive and the company had enough money for the 3 of them, then it should invest in all of them. But that is not the case, here, since the company has to decide in which project it will invest (only 1 project). The first option should be project 3, but since it cannot be repeated, and its life is short, I would go for project 1.

    Besides, it is the only possible answer since you have to choose only 1 project (remember projects are mutually exclusive).

    Reply

Leave a Comment

sixty one + = 66