Question

The firm is planning to invest up to £65 million next year. The information about the available investment projects is given in the table below.

Project	Initial investment, millions of £	Internal rate of return	Net present value, millions of £	Profitability index
A	50	15%	12
B	35	19%	15
C	30	28%	42
D	25	26%	1
E	15	20%	10
F	10	37%	11
G	10	25%	13
H	1	18%	0.1

Assuming the projects are not divisible, use the profitability index(PI) as a criterion to determine the value-maximizing combination of projects. Show the calculations of the profitability indexes in the final column of the table.

Answer 1

Project	Initial Investment	NPV	Cash Flows (NPV + Initial Investment)	PI (Cash Flows/Initial Investment)	Ranking	Investments in Projects chosen
A	50	12	62	1.24	6
B	35	15	50	1.43	5
C	30	42	72	2.40	1	30
D	25	1	26	1.04	8
E	15	10	25	1.67	4	15
F	10	11	21	2.10	3	10
G	10	13	23	2.30	2	10
H	1	0.1	1.1	1.10	7
						65

If the PI is greater than 1, the project generates value and the company may want to proceed with the project. The higher the profitability index, the more attractive the investment.

Projects to be chosen = Project C, Project G, Project F, Project E