ABC Corporation is evaluating two mutually exclusive projects, Project X and Project Y, both requiring a capital investment of $500,000. The company has a budget constraint that prevents any single project from exceeding $450,000. The projects are expected to generate the following cash flows over the next five years: Project X: Year 1: $150,000, Year 2: $200,000, Year 3: $250,000, Year 4: $300,000, Year 5: $350,000 Project Y: Year 1: $50,000, Year 2: $150,000, Year 3: $250,000, Year 4: $450,000, Year 5: $500,000 Assuming the projects are independent and the firm seeks to maximize its NPV while adhering to the capital rationing constraint, which project should the firm choose?

Exam

CFA Level 1

Section

Difficulty

Corporate Finance

Capital Rationing Decision for ABC Corporation

Hard Capital Budgeting Capital Rationing

ABC Corporation is evaluating two mutually exclusive projects, Project X and Project Y, both requiring a capital investment of $500,000. The company has a budget constraint that prevents any single project from exceeding $450,000. The projects are expected to generate the following cash flows over the next five years:

Project X: Year 1: $150,000, Year 2: $200,000, Year 3: $250,000, Year 4: $300,000, Year 5: $350,000
Project Y: Year 1: $50,000, Year 2: $150,000, Year 3: $250,000, Year 4: $450,000, Year 5: $500,000

Assuming the projects are independent and the firm seeks to maximize its NPV while adhering to the capital rationing constraint, which project should the firm choose?

Project X, because it provides higher cash inflow in earlier years.

Project Y, because it generates more cash flow in the later years.

Neither project, as both exceed the capital budget of $450,000.

Hint

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