Marrietta Supply has 1 million available to invest this peri

Marrietta Supply has $1 million available to invest this period. The cost of capital is 10% and is expected to remain at 10% in future periods. The company faces capital rationing and will not be able to raise additional funds. The capital rationing and will not be able to raise additional funds. The capital rationing is expected to last for 2 years. Funds available at year 1 can be invested to earn 20% for the remaining year. Any idle funds not invested in capital investments now can be invested in temporary money market securities at an 8.3 % return for 1 year. The company is considering one investment. The investment will require an initial outlay of $1,000,000. This investment will provide cash flows of $400,000 after 1 year and $800,000 after 2 years. Is the investment attractive?

Solution

Present Available Fund = $ 1,000,000

1. Investment 1 @ 20 % ,

Maturity Value = $ 1,000,000 X 1.2 = $ 1,200,000

Present Value = $ 1,200,000 X PVF ( 2, 10 % ) - $ 1,000,000

= $ 1,200,000 X 0.83 - $ 1,000,000 = $ ( 8,264)

2. Investment 2

Year Cash Flow Present Value Factor @ 10 % Present Value

   0 ($ 1,000,000) 1 ($ 1,000,000)

1 $ 400,000 0.91 $ 363,636  

2 $ 800,000 0.83 $ 661,157

Net Present Value $ 24, 793

Prposed Investment is feasible. Attractive as it earns more than investing 20 % or 5 %