Question

Jill Harrington, a manager at Jennings Company, is considering several potential capital investment projects. Data on these projects follow: Project X Project Y Project Z Initial investment $40,000 $20,000 $50,000 Annual cash inflows 25,000 10,000 25,400 PV of cash inflows 45,000 33,000 70,000 Required: 1. Compute the payback period for each project and rank order them based on this criterion. (Round your answers to 2 decimal places.) 2. Compute the NPV of each project and rank order them based on this criterion. 3. Compute the profitability index of each project and rank order them based on this criterion. (Round your answers to 2 decimal places.) 4. If Jennings has limited funds to invest, which ranking should Jill recommend? Payback Ranking NPV Ranking Profitability Index Ranking

Answer 1

1. payback period is the number of years in which the initial investment of a project is recovered.

Payback period = Investment / Annaul cash flows

Project X = $40000/25000 = 1.6 years

Project Y = $20000/10000 = 2 Years

Project Z = $50000/25400 = 1.97 years

2. NPV = Present value of cash inflows - cash outflows

Project X = $45000 - 25000 = $20000

Project Y = $33000 - 10000 = $23000

Project Z = $70000 - 25400 = $44600

3. Profitability index = Present value of cash inflows / cash outflows.

Project X = $45000 / 25000 = 1.8

Project Y = $33000 / 10000 = 3.3

Project Z = $70000 / 25400 = 2.76

4. The ranking is as below:

	Payback period	NPV	Profitabiltiy Index
Project X	1	3	2
Project Y	3	2	1
Project Z	2	1	3