Question

Fabulous Fabricators needs to decide how to allocate space in its production facility this year. It is considering the following? contracts:

Contract	NPV	Use of Facility
A	$ 1.96$1.96 million	100 %100%
B	$ 1.05$1.05 million	60 %60%
C	$ 1.47$1.47 million	40 %40%

a. What are the profitability indexes of the? projects?

The profitability index for contract A is

Nothing. ????

The profitability index for contract B is

nothing.????

The profitability index for contract C is

nothing.???

b. What should Fabulous Fabricators? do????(Select the best choice? below.)

A. Since it has the capacity to do both B and C and NPV Subscript Upper B Baseline plus NPV Subscript Upper CNPVB+NPVC is greater than NPV Subscript Upper ANPVA?,

it should do both B and C.

B. Since the NPV of A is the? largest, it should choose A.

C. Since the profitability index for C is the? largest, it should choose C.

D. It should take the two projects with the highest profitability? indexes: C and A.

Answer 1

a) Profitability Index = NPV/Use of Facility

Profitability Index for contract A = 1.95/100% = 1.95

Profitability Index for contract B = 1.05/60% = 1.75

Profitability Index for contract C = 1.47/40% = 3.675

b) The answer is option A) i.e it should do both contracts B & C. Reasons are as follows:

- B & C will allow total use of facility i.e. 60%+40% = 100%

- NPV of both the projects together ($2.52mn ) is more than the NPV of project A ($1.95mn)

-Profitability Index of both projects is more than 1 which makes them acceptable projects.

Note: Contracts A & C cannot be taken up together as use of facility % is more than the available capacity.