# Thus npv 600000 for project a 450000 for project b

• Notes
• 5
• 98% (45) 44 out of 45 people found this document helpful

This preview shows page 4 - 5 out of 5 pages.

Thus, NPV = \$600,000 for project A, \$450,000 for project B, and \$300,000 for project C. With capital rationing, the firm can undertake either project A only or projects B and C. Ranking projects according to their NPV , the firm would undertake projects B and C with total NPV of \$750,000 ( b ) Since the firm faces capital rationing, however, it should use the profitability index ( PI ) as its investment criterion. The PI of each project is given by the ratio of the PVNCF to the C 0 of each project For project A, PI = \$3,000,000/\$2,400,000 = 1.25. For project B, PI = \$1,750,000/\$1,300,000 = 1.35. For project C, PI = \$1,400,000/\$1,100,000 = 1.27. Using the PI investment criterion indicates that the firm should undertake projects B and C. The reason for this is that projects B and C provide a higher rate of return per dollar invested than project A. Note that the sum of the NPV of projects B and C exceeds the NPV for project A. 10. The cost of equity capital for this firm ( ke ) can be calculated with the dividend valuation model, as follows ke = ( D/P) + g where D is the amount of the yearly dividend paid per share of the common stock of the firm, P is the price of a share of the common stock of the firm, and g is the expected annual growth rate of dividend payments. Since the company pays half of its expected \$200 million in net after-tax earnings in dividends and there are 100 million shares of common stock of the firm, the dividend per share is \$1. With a share of the common stock of the firm selling for eight times current earnings, the price of a share of the common stock of the firm is \$8. With the expected annual growth of earnings and dividends of the firm of 7.5 percent, the cost of equity capital for this firm is ke = (\$1/\$8) + 0.075 = 0.125 + 0.075 = 0.20 or 20%

Subscribe to view the full document.

Spreadsheet problem 1: The present value of net revenue is \$760. The firm should purchase the machine since the NPV of the project is positive.

{[ snackBarMessage ]}

Upload your study materials now and get free access to over 25 million documents.

Upload now for FREE access Or pay now for instant access
###### "Before using Course Hero my grade was at 78%. By the end of the semester my grade was at 90%. I could not have done it without all the class material I found."
— Christopher R., University of Rhode Island '15, Course Hero Intern

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern