Question

An investment costs $200,000. If the present value (PV) of all the future cash flows is...

An investment costs $200,000. If the present value (PV) of all the future cash flows is $175,000, which of the following statements is correct?

a.

The project should be rejected since the Profitability Index is less than 1.
b.

The project should be rejected since the NPV is $25,000.
c.

The project should be accepted since the Profitability Index is greater than 0
d.

The project should be rejected since the NPV is -$175,000.
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Answer #1

An investment costs $200,000. If the present value of all the future cash flows is $175,000, the following statement is true-

A) The project should be rejected as the Profitability Index is less than 1.

The profitability index of the project will be $175,000/$200,000 = 0.875, which is less than 1. Hence, the project should be rejected.

NPV of the project is = Pv of future cash flows - Initial investment

= $175,000 - $200,000 = -$25,000

It is -$25,000 and not -$175,000 or $25,000.

Do let me know in the comment section in case of any doubt.

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