Question

Information on four investment proposals is given below: Investment required Present value of cash inflows Net present value Life of the project Investment Proposal A B C D $(390,000) $(30,000) $(40,000) $(600,000) 551,000 41,000 64,100 800,000 $ 161,000 $ 11,000 $ 24,100 $ 200,000 5 years 7 years 6 years 6 years Required: 1. Compute the project profitability index for each investment proposal. (Round your answers to 2 decimal places.) 2. Rank the proposals in terms of preference. Investment Proposal Project Profitability Index Rank Preference A B с D

Answer 1

Profitability index = Present value of cash Inflow/ Initial investment

Project A

Profitability index = 551,000/390,000

= 1.41

Project B

Profitability index = 41,000/30,000

=1.37

Project C

Profitability index = 64,100/40,000

=1.60

Project D

Profitability index = 800,000/600,000

= 1.33

B)

Higher the profitability index, better is the investment. Therefore highest profitability index will be ranked one and so on...

Project A has second highest profitability index therefore it will be ranked 2nd.

Project B has third highest profitability index therefore it will be ranked 3rd.

Project C has the highest profitability index therefore it will be ranked 1st.

Project D has the lowest profitability index therefore it will be ranked 4th.

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