A. First, if all four projects are accepted, Mercken would exceed its capital budget for the year. And second, Project S is completely unacceptable because it has a negative NPV. Therefore, this answer should be rejected.
B. If Mercken chooses Projects P, Q and R, it will exceed its capital budget for the year.
C. This is a situation where there appears to be a conflict between the NPV results and the IRR results. Projects P and Q have the higher IRRs, whereas Q and R have the higher NPVs. However, the problem also tells us that the cash inflows from the project will be able to be reinvested at a rate no higher than 12%. Thus, the IRRs for these projects are not accurate. Furthermore, Projects P and Q do not have the highest excess present value (profitability) indices.
D. Project S is not an acceptable project, because it has a negative NPV. That leaves Projects P, Q and R. However, if all three projects were selected, Mercken would exceed its capital budget of $450,000. Therefore, only two of the three projects can be selected. This is a situation where there appears to be a conflict between the NPV results and the IRR results. Projects P and Q have the higher IRRs, whereas Q and R have the higher NPVs. Remember that the IRR assumes that all cash inflows from the project will be able to be reinvested at the internal rate of return. However, this problem tells us that the cash inflows from the project will be able to be reinvested at a rate no higher than 12%. Thus, the IRRs for these projects are not accurate. Therefore, the projects with the highest NPVs should be selected, and those are Projects Q and R. This is confirmed by looking at the excess present value (profitability) indices. Note that Projects Q and R have the highest profitability indices.
