Question

A firm has set a budget constraint of $220,000 on new investments, which cannot be exceeded. Given the following independent investments, which projects should the firm undertake?

Project		CF0		PI
Alpha		$80,000		1.20
Delta		$120,000		1.13
Gamma		$140,000		1.10
Sigma		$85,000		1.15

Projects Alpha and Delta

Projects Alpha and Gamma

Projects Alpha and Sigma

Projects Venus and Jupiter

Answer 1

It is quoted that the budget constraint is of $220,000. Projects with highest NPV considering the budget amount is selected. Formula to calculate PI (profitability index) is as follows: NPV Initialinvestment PI= Initialinvestment Here, initial investment is CF, for the respective projects Requoting the PI formula, NPV for the projects can be calculated as follows: NPV=PIx Initial investment- Initial investment X Project PI NPV=PIx Initial investment - Initial investment CF X 0 $ 16,000 Alpha $80,000 1.20 120x $80, 000-$80,000 $120,000 Delta 1.13 1.13x$120,000-$120, 000 $15,600 1.10x$140,000-$140,000 $14,000 $140,000 1.10 Gamma Sigma $85,000 1.15 1.15x $85,000-$85,000 $12,750 Thus, projects with highest NPV are Alpha and delta. Also considering the budget constraint of $220,000. Total cost of project alpha and delta is $200,000, that is in the budget constraint of the firm Therefore, the correct option is Project A lpha and Delta