Answer:
Bigfella Conglomerate Inc.
Capital rationing:
To select projects subject to a budget constraint of 5 million dollars, the set of projects that should be accepted in order to maximize firm value are:
Projects 1 and 4. These projects yielded the highest annual returns and NPV, and the combination could survive under the budget constraint.
Explanation:
a) Data and Calculations:
Project Initial
Outlay IRR NPV Expected Annual Returns
1 2 million 18% 2,500,000 $360,000 (18% * $2 million)
2 1 million 15% 950,000 $150,000 (15% * $1 million)
3 1 million 10% 600,000 $100,000 (10% * $1 million)
4 3 million 9% 2,000,000 $270,000 (9% * $3 million)
b) Based on a budget constraint of $5 million, the set of projects that should be accepted to maximize firm value is:
Project Initial
Outlay IRR NPV Expected Annual Returns
1 2 million 18% 2,500,000 $360,000 (18% * $2 million)
4 3 million 9% 2,000,000 $270,000 (9% * $3 million)
Total 5 million 4,500,000 $630,000
c) In terms of the net present value of cash inflows versus cash outflows, projects 1 and 4 perform far better than projects 2 and 3 combined with project 4. The expected annual returns based on the Internal Rate of Return (IRR) also indicate that the combination of projects 1 and 4 outperform any other combination of projects.
