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

A firm has capital of $500,000 available and evaluates three indivisible projects. Project X: investment $300,000, PV of future cash flows $375,000. Project Y: investment $200,000, PV of future cash flows $260,000. Project Z: investment $500,000, PV of future cash flows $610,000. The firm's best decision is most likely to:

The firm should accept Projects X and Y, giving a combined NPV of $135,000. Together they use exactly the $500,000 budget and beat Project Z alone at $110,000. Under capital rationing, the choice should maximize total NPV across feasible combinations, not the largest single project.

  1. Aaccept Projects X and Y, for a combined NPV of $135,000Correct
  2. Baccept Project Z only, for an NPV of $110,000
  3. Caccept Project X only, for an NPV of $75,000

Explanation

NPVs: X = 75,000 (PI 1.25), Y = 60,000 (PI 1.30), Z = 110,000 (PI 1.22). With a 500,000 budget, X+Y costs 500,000 and gives NPV 135,000, exceeding Z alone at 110,000. Choosing Z because it has the largest single NPV, or ranking only by PI, ignores the best combination under the constraint.

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