Problem:
Galaxy Satellite Co. is attempting to select the best group of independent projects competing for the firm's fixed capital budget of $10,000,000. Any unused portion of this budget will earn less than its 20 percent cost of capital. A summary of key data about the proposed projects is illustrated below:
Q1. Use the NPV approach to select the best group of projects. (Note that just the PV of inflows is given, you must subtract the initial investment to find the NPV.)
Q2. Use the IRR approach to select the best group of projects. (Note that the discount rate or the cost of capital is 20%.)
Q3. Which projects should the firm implement based on your analysis of both techniques and given the capital rationing amount? Write an email to your boss, Andy Fast, the CFO, explaining your rationale proving the choices based on the considerations of shareholder value and the maximum investment budget.
| Project |
Initial Investment |
IRR |
PV of Inflows at 20% |
| A |
$3,000,000 |
21% |
$3,050,000 |
| B |
9,000,000 |
25 |
9,320,000 |
| C |
1,000,000 |
24 |
1,060,000 |
| D |
7,000,000 |
23 |
7,350,000 |