Borghia Pharmaceuticals has $1 million allocated for capital expenditures. a. Which of the following projects should the company accept to stay within the $1 million budget? b. How much does the budget limit cost the company in terms of its market value? The opportunity cost of capital for each project is 11%. Borghia Pharmaceuticals Investment NPV IRRProject ($ Thousands) ($ Thousands) (%)1 300 66 17.22 200 -4 10.73 250 43 16.64 100 14 12.15 100 7 11.86 350 63 187 400 48 13.5

With a limited budget, the firm will first pursue projects with the highest return, and the allocate the remaining capital to the project with the second highest return, and so on until all capital is fully allocated. Based on the information, Project 6 has the highest return, followed by 1 and 3. These three projects together will cost:

350,000 + 300,000 + 250,000 = $900,000

After those three projects, the firm will have $100,000 left. The best out of remaining project is 7, but it costs 400,000, which the firm cannot afford. The best affordable project is 4, which offers a return of 12.1%. Hence, the firm should spend the remaining 100,000 on project 4.

b)

The budget limit constraints the firm to give up project 7, which offers a NPV of $48,000. The firm is forced to choose project 4, which has a NPV of $14,000.

Thus the lost in market value of the firm = 48,000 - 14,000 = $34,000.

dubeyshailja64 dubeyshailja64 · Answer 2 · 2022-02-25T12:55:33+01:00

The projects that should be accepted are 1, 3, 4, and 6. The budget limit costs the company a loss of $34,000.

What is an investing decision?

Investing decision refers to the rational decision regarding an investment based on its profitability and returns.

The investing decisions if taken on the basis of NPV, the project with higher NPV are selected. And on the other hand, if IRR is taken as the base for investing decisions, the projects with higher IRR are preferred.

Based on the above statement, the projects 1,3,6, and 7 give the highest NPV. But the budget is up to $1 million, the decision should be taken rationally.

Hence the projects 1,3, and 6 will be chosen. The total investment in these projects will be $9 million.

The company can invest remaining 1 million in either 4 or 5. The NPV of project 4 is higher therefore it should be taken.

Hence the projects invested are 1,3,4, and 6.

The cost company incurred on investing in project 4 rather in 7 is the opportunity cost.

The loss will be difference in NPV of both the projects that is $34,000.

Learn more about investing decisions here:

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