A company in Arkansas is reviewing 7 capital investment proposals. The funds tha

Question

A company in Arkansas is reviewing 7 capital investment proposals.  The funds that wer available are limited to the maximum amount of $12 million.  Each project is stand alone and have the below costs and profitability indexes.

a.  While using capital rationing which projects should be selected and why?

b.  What are common problems with capital rationing?

Project                                         Cost                  Profitability Index

New Park                                    $4 million            1.18

Common area expansion             3 million            1.08

Upgrade facility                            5 million             1.33

Walking Trail                                6 million             1.31

Exercise facility                            4 million             1.19

Parking garage                            6 million             1.20

Storm Shelter                               4 million             1.18

Explanation / Answer

if projects are divisible -PI method

upgrade facility=5 million

walking trail= 6 million

parking garage =1 milion

as this all projects PI is highest so this projects should be selected.

b. Problems of Capital Rationing include the problem of distinguishing between acceptable and unacceptable investments which is faced by top managers and problem of allocating sums among competing investments and the problem of making concrete proposals for expenditures.

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