Leslie is charged with determining which small projects should be funded. along with this assignment, she has been granted the use of $15,000 for a maximum of two years on a discounted basis. she is considering three projects. project a costs $7,500 and has cash flows of $4,000 a year for years 1 to 3. project b costs $8,000 and has cash flows of $3,000, $4,000, and $3,000 for years 1 to 3, respectively. project c costs $2,000 and has a cash inflow of $2,500 in year 2. what decisions should she make regarding these projects if she assigns them a mandatory discount rate of 8.5 percent? explain why.

The answer is: Leslie should fund projects A and C

Explanation:

In order to determine if a project should be accepted, the first thing Leslie has to do is determine the projects´ Net Present Value (NPV). If the NPV is 0 or more, then the projects could be funded.  

The formula to calculate NPV is:

             NPV = ∑{p/( 1+r)t} - C

Project A:

p = $4000;$4000;$4000

r = 8.5%

t = 3

c = $7,500

The NPV for Project A is $2,716.09

Project B:

p = $3000;$4000;$3000

r = 8.5%

t = 3

c = $8,000

The NPV for Project B is $511.52

Project C:

p = $0;$2,500

r = 8.5%

t = 2

c = $2,000

The NPV for Project C is $123.64

Once you calculate the NPVs from projects A,B and C you must determine how to distribute the $15,000 available. All three projects have positive NPVs, so they are profitable. But you can´t fund projects A and B since their combined costs ($7,500 + $8,000 = $15,500) exceeds $15,000. Leslie should invest in project A since its NPV is higher ($2,716.09 ˃ $511.52). She should also fund project C since its NPV is positive ($123.64) and the capital needed is smaller (only $2,000).

rational decision making is a multi-step process for making choices between alternatives. the process of rational decision making favors logic, objectivity, and analysis over subjectivity and insight. the word “rational” in this context does not mean sane or clear-headed as it does in the colloquial sense.

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