Textbook Problem

The Tatham Company is considering seven investments. The cash required for each investment and the net present value (NPV) each investment adds to the firm are listed in Table 6.1. Each NPV is based on a stream of future revenues, and it includes the cash requirement, which is incurred right away. The table also lists the return of investment (ROD for each investment, defined as the ratio of NPV to cash required, minus 1. The budget for investment is $15 million. Tatham wants to find the investment policy that maximizes its total NPV. The crucial assumption here is that if Tatham wants to take part in any of these investments, it must go all the way. It cannot, for example, go halfway in investment 1 by investing $2.5 million and realizing an NPV of $2.8 million. In fact, if partial investments were allowed, you wouldn’t need IP; you could use LP.

Table 6.1 Data for the Capital Budgeting Example ($ millions)

Expand and then solve the capital budgeting model in Figure 6.5 so that 20 investments are now possible. You can make up the data on cash requirements, NPVs, and the budget, but use the following guidelines:

• The cash requirements and NPVs for the various investments can vary widely, but the ROIs should be between 10% and 15% for each investment.
• The budget should allow somewhere between 5 and 10 of the investments to be selected.