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	$	(570,000	)	$	(500,000	)	$	(370,000	)	$	(340,000	)
Present value of cash inflows at a 11% discount rate		603,219			584,233			385,015			366,546
Net present value	$	33,219		$	84,233		$	15,015		$	26,546
Life of the project		6 years			12 years			6 years			3 years
Internal rate of return		13	%		14	%		12	%		15	%

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.

project profitability index

1

2

3

4

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

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

	Net Present Value	Project Profitability Index	Internal Rate of Return
First preference	2selected answer correct
Second preference	1selected answer correct		2selected answer correct
Third preference	4selected answer correct
Fourth preference	3selected answer correct

Answer 1

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

project profitability index

1
Project profitability index=Net present value /Investment required
Project	Profitability index
1	0.058	=33,219/570,000
2	0.16	=84233/500,000
3	0.040	=15,015/370000
4	0.078	=26,546/340000
2
	Net Present value	Project Profitability index	Internal rate of return
First preference	2	2	4
Second preference	3	4	3
Third preference	1	3	2
Fouth preference	4	1	1

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