The capital budgeting committee for Laroche Industries is meeting. Laroche is a North American conglomerate that has several divisions. One of these divisions, Laroche Livery, operates a large fleet of vans. Laroches management is evaluating whether it is optimal to operate new vans for two, three, or four years before replacing them. The managers have estimated the investment outlay, annual after-tax operating expenses and after-tax salvage cash flows for each of the service lives. Because revenues and some operating costs are unaffected by the choice of service life, they were ignored in the analysis. Laroche Liverys opportunity cost of funds is 10 percent. The following table gives the cash flows in thousands of Canadian dollars (C$).

Service Life	Investment	Year 1	Year 2	Year 3	Year 4	Salvage
2 years	-40,000	-12,000	-15,000			20,000
3 years	-40,000	-12,000	-15,000	-20,000		17,000
4 years	-40,000	-12,000	-15,000	-20,000	-25,000	12,000

Schoeman Products, another division of Laroche, has evaluated several investment projects and now must choose the subset of them that fits within its C$40 million capital budget. The outlays and NPVs for the six projects follow. Schoeman cannot buy fractional projects and must buy all or none of a project. The currency amounts are in millions of Canadian dollars.

Project	Outlay	PV of Future Cash Flows	NPV
1	31	44	13
2	15	21	6
3	12	16.5	4.5
4	10	13	3
5	8	11	3
6	6	8	2

Schoeman wants to determine which subset of the six projects is optimal.

A proposal comes from the division Society Services. The cash flows relating to the project is as follows:

An outlay of C$190 million at time 0.

Cash flows of C$40 million per year for years 1-10 if demand is high.

Cash flows of C$20 million per year for years 1-10 if demand is low.

The probability of high demand is 0.50, and the probability of low demand is 0.50.

The required rate of return is 10 percent.

The internal auditor for Laroche Industries has made several suggestions for improving capital budgeting processes at the company. The internal auditors suggestions are as follows:

Suggestion 1: In order to put all capital budgeting proposals on an equal footing, the projects should all use the risk-free rate for the required rate of return.

Suggestion 2: When rationing capital, it is better to choose the portfolio of investments that maximizes the company NPV than the portfolio that maximizes the company IRR.

1. What is the optimal service life for Laroche Liverys fleet of vans?
   1. Two years
   2. Three years
   3. Four years
   4. Three and four years are equally attractive.

2. The optimal subset of the six projects that Schoeman is considering consists of which projects?
   1. 1 and 5
   2. 2, 3, and 4
   3. 2, 3, and 5
   4. 2, 4, 5, and 6

3. What is the NPV (C$ millions) of the project for Society Services?
   1. -6.11
   2. -5.66
   3. 2.33
   4. 5.58

4. Should the capital budgeting committee accept the internal auditors first and second suggestions?

Suggestion 1

Suggestion 2

1. No No
2. No Yes
3. Yes No
4. Yes Yes