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CFA Level I · CFA Level I Exam · Capital Investments and Capital Allocation

A company has more positive-NPV projects available than its capital budget allows, and the budget cannot be increased. Which approach is most likely appropriate for choosing among the projects?

The company should choose the combination of projects that maximizes total NPV within the fixed budget. Capital rationing means not all positive-NPV projects can be funded, so value maximization under the constraint matters. IRR or payback screens alone ignore the budget limit or ignore value creation.

  1. AAccept every project whose IRR exceeds the cost of capital
  2. BChoose the combination of projects that gives the highest total NPV within the budgetCorrect
  3. CAccept projects in order of shortest payback until the budget is spent

Explanation

Under capital rationing the goal is to maximize total NPV subject to the budget constraint, so the best combination of projects is selected. Accepting all projects with IRR above the cost of capital would exceed the budget. Ranking by payback ignores value created beyond the payback period and does not maximize NPV.

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