Which one of the following statements would generally be considered as accurate given independent projects with...

Which one of the following statements would generally be considered as accurate given independent projects with conventional cash flows?

		The profitability index rule cannot be applied in this situation.
		The payback decision rule could override the net present value decision rule should cash availability be limited.
		Business practice dictates that independent projects should have three distinct accept indicators before a project is actually implemented.
		The internal rate of return decision may contradict the net present value decision.
		The projects cannot be accepted unless the profitability index decision ruling is positive.

Expert Solution

Solution.>

Firstly we have to understand what is the meaning of independent projects. Projects are independent if the cash flows of one are not affected by the acceptance of the other. Thus, the funding of an independent project does not depend on another project receiving funding first. Hence we can choose as many projects which are fulfilling our capital budgeting criteria.

Conventional cash flow is a series of inward and outward cash flows over time in which there is only one change in the cash flow direction.

Statement 1 is not correct. The decision rule for the profitability index is that any project with a ratio greater than one is an acceptable project. It is valid in this case.

Statement 2 is correct. The payback decision rule could override the net present value decision rule should cash availability be limited.

Statement 3 is not correct. There is no such business practice dictates that independent projects should have three distinct accept indicators before a project is actually implemented.

Statement 4 is not correct. IRR decision can only contradict the NPV decision in the case of non-conventional cash flows. Non-conventional cash flows are those cash flows where the sign of the cash flows changes for more than a single time. In these cases, we have at least two IRR values where the NPV comes out to be zero. This usually creates ambiguity, unnecessary confusion regarding the correct outcome and hinders our decision of investing in it or not.

Statement 5 is not correct. The profitability index rule is a decision-making exercise that helps evaluate whether to proceed with a project. The index itself is a calculation of the potential profit of the proposed project. The rule is that a profitability index or ratio greater than 1 indicates that the project should proceed. A profitability index or ratio below 1 indicates that the project should be abandoned.

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jeff jeffy answered 2 years ago

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