Single Period Capital Rationing
The following table presents the cash flows associated with Projects A, B, C, D, E and F.
Year 0 1 2 3 4
A -100000 20000 40000 60000 80000
B -150000 -50000 100000 100000 140000
C -60000 20000 40000 40000
D -100000 60000 60000 100000
E -50000 20000 40000 60000 40000
F -100000 30000 30000 30000 30000
Assuming that the firm only has available $300,000 and applies capital rationing.
Assume also that fractions of investment can be undertaken. I.e. they are divisible.
The cost of capital is 10%.
a) Which projects should be acquired?
b) What is the total NPV of the projects acquired?
Now assume that fractions of investment cannot be undertaken.
c) Which projects should be acquired?
d) What is the total NPV of the projects acquired?
Assume now that Projects A and E are mutually exclusive and the projects are
e) Which projects should be acquired?
f) What is the total NPV of the projects acquired?
Black Ltd has identified the following two projects
Year Cash Flow Cash Flow
0 -100000 -140000
1 30000 53000
2 35000 53000
3 40000 53000
4 45000 53000
5 55000 53000
a) Calculate the Net Present Value for each project.
b) Calculate the Internal Rate of Return for each project
c) Using discount rates of 0 per cent, 10 per cent and 20 percent and the IRR calculated
above construct a table that could be used to draw the present value profiles for each
d) Comment on the acceptability and preferability of the projects.
An extract of Green Ltd’s Balance Sheet is as follows
The bonds are currently selling at $245.33 and were issued originally at a face value of $200.
The preference shares were originally issued at a price of $5 each and are currently selling
for $5.75 each.
The ordinary shares were originally issued at a price of $15 each and are currently selling for
The company believes it current financing mix is the one that delivers its long-term optimal
The company wishes to determine its weighted marginal cost of capital
The company has compiled the following data
Source of Capital Range of Financing
Long Term Debt
$0 to $300,000 6.5%
$300,001 to $600,000 7.5%
$600,001 and above 9.0%
Preference Shares 0.00 to $100,000 9.5%
$100,001 and above 10.0%
$0 to $500,000 11.0%
$500,001 to $1,000,000 12.5%
$1,000,001 and above 14.0%
Accounts Receivable $ 125,000
Inventories $ 185,000
Property, Plant & Equipment $3,793,000
Prepayments $ 12,000
TOTAL ASSETS $4,115,000
Accounts Payable $ 90,000
Bank Overdraft $ –
Accrued Revenue $ 25,000
TOTAL LIABILITIES $1,615,000
NET ASSETS $2,500,000
Preference Shares $ 400,000
Ordinary Shares $1,500,000
GeneralReserve $ 125,000
Retained Profit $ 475,000
TOTAL SHAREHOLDERS EQUITY $2,500,000
Investment Initial Useful Annual
Opportunity Investment Life Cash Flows
A -$200,000 4 $68,641
B -$300,000 6 $72,967
C -$500,000 8 $97,161
D -$300,000 3 $120,635
E -$600,000 5 $154,254
F -$100,000 7 $19,207
a) Determine the breaking points and ranges of total financing associated with each source
b) Using the data developed in a., determine the levels of total financing at which the firm’s
weighted average cost of capital (WACC) will change;
c) Calculate the weighted average cost of capital and the weighted marginal cost of capital
(WMCC) for each range of total financing found in b;
d) Using the results of c. along with the information on the available investment opportunities
compile the firm’s investment opportunities schedule (lOS), plot this schedule and plot the
weighted marginal cost of capital
e) Which if any of the available investments would you recommend that the firm accept?
Explain your answer
f) Assume now that Project C is unavailable.Which if any of the available investments would
you recommend that the firm accept? Explain your answer
Explain the common sources of risk affecting financial managers and shareholders