A company has a required rate of return of 15% for five potential projects. The company has a maximum of $500,000 available for investment and cannot raise any capital. Details about the five projects are as follows:
Project Initial Outlay Net Present Value at 15% Internal Rate of Return
1 $500,000 $125,000 23%
2 250,000 75,000 17%
3 150,000 25,000 35%
4 100,000 50,000 25%
5 150,000 50,000 25%
The company should choose which of the following projects?
A. Project 1 only
B. Projects 2, 3, and 4 only
Correct C. Projects 2, 4, and 5 only
D. Projects 3, 4, and 5 only
Here's the explanation before. What I am trying to figure out is why are we adding the NPV and the initial outlay to divide against the initial outlay?
everal alternative projects can be ranked by comparing their profitability indexes (PV (present value) of future cash flows divided by the initial investment). For these projects, the index is found as follows:
$625/$500 = 1.25
$325/$250 = 1.33
$175/$150 = 1.17
$150/$100 = 1.50
$200/$150 = 1.33
The projects with the highest profitability index should be selected first. This includes #4, #2, and #5. At that point the entire $500,000 that is available has been invested in the most profitable alternatives.
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