Problem 5-17 Comparing Investment Criteria The treasurer of Amaro Canned Fruits,
ID: 2646620 • Letter: P
Question
Problem 5-17 Comparing Investment Criteria
The treasurer of Amaro Canned Fruits, Inc., has projected the cash flows of projects A, B, and C as follows:
Compute the profitability index for each of the three projects. (Do not round intermediate calculations. Round your answers to 2 decimal places. (e.g., 32.16))
Compute the NPV for each of the three projects. (Do not round intermediate calculations. Round your answers to 2 decimal places. (e.g., 32.16))
Suppose these three projects are independent. Which project(s) should Amaro accept based on the profitability index rule?
Suppose these three projects are mutually exclusive. Which project(s) should Amaro accept based on the profitability index rule?
Suppose Amaros budget for these projects is $520,000. The projects are not divisible. Which project(s) should Amaro accept?
Problem 5-21 Payback and NPV
An investment under consideration has a payback of six years and a cost of $872,000. Assume the cash flows are conventional.
The treasurer of Amaro Canned Fruits, Inc., has projected the cash flows of projects A, B, and C as follows:
Explanation / Answer
Profitability Index basically measures the relationship between the cost being incurred in a project & the present values of cash inflows occurring out that investment.
Profitability Index = PV of future cash flows/Initial Investment.
PI >1, then accept the project.
PI<1 , then reject the project.
NPV is basically the difference between the sum of present value of all cash inflows which a project generates over the years and the initial investment (cash outflow) of a particular project.
c) If the project is independent, as per profitability Index rule, Project A should be accepted as it has the highest ratio.
d) If the project are mutually exclusive, as per profitability Index rule, Project A should be accepted as it has the highest ratio.
e )If the budget of Amaro is $ 520000 & it is not divisible, then Amaro should accept Project A & B as these two projects combined have the highest NPV.
Worst case NPV would be when the cash inflows expected from a particular project lags behind the initial investment conceived for a particular period. In this case, worst case NPV would be sum of present value of cash flows being less than $ 872000 after discounting them @ 12%.
Particulars Project A Project B Project C Initial Investment 195,000 325,000 195,000