Exercise 13-5 Preference Ranking [LO13-5]
Information on four investment proposals is given below:
| Investment Proposal | ||||||||||||
| A | B | C | D | |||||||||
| Investment required | $ | (190,000 | ) | $ | (180,000 | ) | $ | (170,000 | ) | $ | (900,000 | ) |
| Present value of cash inflows | 267,400 | 249,400 | 259,300 | 1,197,500 | ||||||||
| Net present value | $ | 77,400 | $ | 69,400 | $ | 89,300 | $ | 297,500 | ||||
| Life of the project | 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.
Explanation
1.
The project profitability index for each proposal is:
| Investment Proposal | Net Present Value (a) | Investment Required (b) | Project Profitability Index (a)÷(b) | ||
| A | $ | 77,400 | $ | 190,000 | 0.41 |
| B | $ | 69,400 | $ | 180,000 | 0.39 |
| C | $ | 89,300 | $ | 170,000 | 0.53 |
| D | $ | 297,500 | $ | 900,000 | 0.33 |
2.
The ranking is:
| Investment Proposal | Project Profitability Index |
| c | 0.53 |
| a | 0.41 |
| b | 0.39 |
| d | 0.33 |
Note that proposal D has the highest net present value, but it ranks lowest in terms of the project profitability index.
Thanks
