Preference Ranking Information on four investment proposals is given below: Inve
ID: 2392826 • Letter: P
Question
Preference Ranking
Information on four investment proposals is given below:
Investment Proposal
A B C D
Investment required $(85,000) $(200,000) $(90,000) $(170,000)
Present value of cash flows 119,000 250,000 135,000 221,000
Net present value $34,000 $50,000 $45,000 $51,000
Life of the project 5 years 7 years 6 years 6 years
Required:
Compute the project profitability index for each investment proposal.
Rank the proposals in terms of preference.
Explanation / Answer
Profitability index = present value of future cash flows / initial investment = (initial investment + net present value) /initial investment
Investment proposal A
Profitability index = (85000+34000)/85000 = 1.40
Investment proposal B
Profitability index = (200000+50000)/200000 =1.25
Investment proposal C
Profitability index = (90000+45000)/90000 = 1.50
Investment proposal D
Profitability index = (170000+51000)/170000 = 1.30
Ranking :
Rank 1 - investment proposal C (because it has highest Pi)
Rank 2 - investment proposal A
Rank 3 - investment proposal D
Rank 4 - investment proposal B (because it has lowest PI)