Thus npv 600000 for project a 450000 for project b

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%
Image of page 4

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.
Image of page 5

{[ snackBarMessage ]}

Get FREE access by uploading your study materials

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
Christopher Reinemann
"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

Ask a question for free

What students are saying

  • Left Quote Icon

    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.

    Student Picture

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

  • Left Quote Icon

    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.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    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.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern