# Heads-Up14: Schweser Capital Rationing

I find it odd that Schweser does not explain how to pick the projects if you have a limited budget! On pages 243-244, they list 5 projects, each with outlay and NPV, and they just remark that you do not necessarily pick the ones with highest NPV, and they seem to just do it by trial and error. Of course, there is a way to do that.

Yes, but on the test choose from the 3 options that maximises total NPV while maintaining outlay constraints & ensuring you choose only the +ve NPV ones

yes you can solve it with the Excel Solver.

Really it’s that difficult?

I thought it works if you sort them from highest to lowest NPV/outlay, then start with the highest and move on until you run out of money.

Assume you have 1,000,000 to invest. There are only 3 investment options and they are not mutually exclusive: A) Outlay = 750,000. NPV = +2,000,000 B) Outlay = 748,000. NPV = +1,800,000 C) Outlay = 251,000. NPV = +250,000 Which combination should you choose?

I’d borrow \$1000 and pick A and C!

wow, all along I thought NPV/outlay would work. So, clearly if they throw in 5 or more projects, we could spend the whole exam time trying to figure out the combination.

Fortunately the exam only has 3 choices, so we just try each answer and use backward induction. Shouldn’t be too bad.

When you think about it,choosing B and C will wipe out your entire budget for an NPV of \$2,050,000. It’s obvious that NPV is not the right method, because you are better off getting \$2m NPV from project A, and investing the remaining \$250k at the risk-free rate, if no other projects are available!

In what world can you invest \$250k at the risk free rate and earn \$50k? Risk free rate right now is 0%!

Not if they say, the combined optimal NPV is:

A. \$2m

B. \$1.75m

C. \$2.1m

Even if at 0%, you will have at least an additional \$250 at the end!

gotcha, didn’t I?

No. Actually, I don’t understand what you mean. Wouldn’t we have \$50k less at the end?

If you choose A, you will spend \$750k and keep \$250k in cash. The project you chose has a value today of \$2m…your networth is \$2m + \$250k = \$2,250,000 .

If you choose B and C, you will spend \$1million. The two projects’ value is \$1.8+\$250k=\$2,050,000. Your networth is \$2,050,000. So why choose B and C?

I mean, if I understand you correctly, then by your logic, it would be best to invest the entire \$1,000,000 at the 0% risk free rate. So I must be misunderstanding. haha

Ah, now I understand. Good point. What would CFAI say?!

Really though. What would they say in this scenario? I still think their answer would be B + C, rather than A. And all I want to know is CFAI’s answer!

I think you would still go for BC. If you hold money and invest it at rf. rf is less than you WACc or require rate of return. Since WACC higher than rf, the NPV of your cash is worth less.

Dont quote, but if investor give you cash they want their require rate of return. If the want risk free they did put it in a bank

I think you would still go for BC. If you hold money and invest it at rf. rf is less than you WACc or require rate of return. Since WACC higher than rf, the NPV of your cash is worth less.

Dont quote, but if investor give you cash they want their require rate of return. If the want risk free they did put it in a bank