Question

Jill Harrington, a manager at Jennings Company, is considering several potential capital investment projects. Data on these projects follow:

	Project X	Project Y	Project Z
Initial Investment	40,000	20,000	50,000
Annual Cash Inflows	25,000	10,000	25,400
PV of cash inflows	45,000	33,000	70,000

1. Compute the payback period for each project and rank order them based on this criterion.

2. Compute the NPV of each project and rank order them based on this criterion.

3. Compute the profitability index of each project and rank order them based on this criterion.

4. If Jennings has limited funds to invest, which ranking should Jill recommend?

Answer 1

1. Payback Period Formula for Payback period = Initial Investment / Annual Cash Inflows Calculation ov Payback Period Project Project Y Project Z Initial Investment 40000 20000 50000 Annual Cash Inflows 25000 10000 25400 cua/b Payback Period in Years) 1.60 2.00 1.97 1st 3rd 2nd Rank The Lesser Payback period the better the Project 3. Net Present Value Calculation ov Net Present Value Project Project Y Initial Investment 40000 20000 b Present Value of cash Inflows 45000 33000 cua-b Net Present Value 5000 13000 Project Z 50000 70000 20000 3rd 2nd ist Rank The Higher NPV the better the Project 3. Profitibility Index Formula for Profitibility Index = Present value of cash flows / Initial Investment Calculation ov Net Present Value Project X Project Y Initial Investment 40000 20000 b Present Value of cash Inflows 45000 33000 cab/a Profitibility Index 1.13 1 .65 Project Z 50000 70000 1.40 3rd 1st 2nd Rank The Higher Profitibility index the better the Project

4 If the Jennings has limited funds to invest than the Ranking as per NPV is best as the investment would be lowest for the higher profits Investment as per NPV ranking Investment NPV Project 2 50000 20000 Project Y 20000 13000 Total 70000 33000