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	$	(550,000	)	$	(500,000	)	$	(400,000	)	$	(520,000	)
Present value of cash inflows at a 11% discount rate		617,520			664,110			463,140			628,320
Net present value	$	67,520		$	164,110		$	63,140		$	108,320
Life of the project		8 years			16 years			8 years			5 years
Internal rate of return		14%			16%			15%			19%

  

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. (Round your answers to 2 decimal places.)

   

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

    

Answer 1

Ans 1. Profitability Index = Present Value of Inflows/Present value of outflows

Particulars	Project 1	Project 2	Project 3	Project 4
Present Value of Inflows (A)	$617520	$664110	$463140	$628320
Present value of outflows (B)	(550000)	(500000)	(400000)	(520000)
Profitability Index (A/B)	1.12	1.33	1.16	1.21

Ans 2. Rank of projects are as under:-

High profitability index is good for the project

Particulars	Rank
project 1	4
project 2	1
project 3	3
Project 4	2