Question

The management of Revco Products is exploring four different investment opportunities. Information on the four projects under study follows:

	Project Number
	1			2			3			4
Investment required	$	(610,000)		$	(560,000)		$	(410,000	)	$	(320,000)
Present value of cash inflows at a 8% discount rate	$	647,538		$	648,059		$	471,500		$	360,735
Net present value	$	37,538		$	88,059		$	61,500		$	40,735
Life of the project		6 years			12 years			6 years			3 years
Internal rate of return		10	%		11	%		13	%		15	%

Because the company’s required rate of return is 8%, a 8% discount rate has been used in the present value computations above. Limited funds are available for investment, so the company can’t accept all of the available projects.

Required:

1. Compute the project profitability index for each investment project.

2. Rank the four projects according to preference, in terms of net present value, project profitability index and internal rate of return.

Answer 1

Solution:

A) Project Profitability Index:

Profitability of Index = Net Present Value / Investment Required

Calculation of Profitability Index
Particulars	Project - 1	Project - 2	Project - 3	Project - 4
Investment Required (A)	6,10,000	5,60,000	4,10,000	3,20,000
Net Present Value (B)	37,538	88,059	61,500	40,735
Profitability Index (B/A)	0.061538	0.157248	0.150000	0.127297

Investment Proposal	Project Profitability Index
Project - 1	0.06154
Project - 2	0.15725
Project - 3	0.15000
Project - 4	0.12730

B. Project Preference Ranks:

Particulars	Net Present Value	Profitability Index	Internal Rate of Return
First Preference	2	2	4
Second Preference	3	3	3
Third Preference	4	4	2
Fourth Preference	1	1	1

Please give a Posirtive Rating.