Question

The management of Revco Products is exploring four different investment opportunities. Information on the four projects under study follows:

	Project Number
	1			2			3			4
Investment required	$	(560,000	)	$	(510,000	)	$	(410,000	)	$	(350,000	)
Present value of cash inflows at a 11% discount rate		592,636			577,822			452,691			440,021
Net present value	$	32,636		$	67,822		$	42,691		$	90,021
Life of the project		6 years			12 years			6 years			3 years
Internal rate of return		13	%		14	%		15	%		25	%

Because the company’s required rate of return is 11%, a 11% discount rate has been used in the present value computations above. Limited funds are available for investment, so the company can’t accept all of the available projects.

Required:

1. Compute the project profitability index for each investment project.

2. Rank the four projects according to preference, in terms of net present value, project profitability index and internal rate of return.

Answer 1

1
Project Profitability index = Net present value/Investment required
Project	Project Profitability index
1	0.06	=32636/560000
2	0.13	=67822/510000
3	0.10	=42691/410000
4	0.26	=90021/350000
2
	Net Present value	Project Profitability index	Internal rate of return
First preference	4	4	4
Second preference	2	2	3
Third preference	3	3	2
Fourth preference	1	1	1