Question
In: Finance
You are chairperson of the investment committee at your firm. Five projects have been submitted to...
You are chairperson of the investment committee at your firm. Five projects have been submitted to your committee for approval this month. The investment required and the project profitability index for each of these projects are presented in the following table:
| Project | Investment | PI | ||
| A | $14,800 | 2.500 | ||
| B | 37,000 | 2.000 | ||
| C | 51,800 | 1.750 | ||
| D | 7,400 | 1.000 | ||
| E | 59,200 | 0.800 |
If you have $370,000 available for investments, which of these
projects would you approve? Assume that you do not have to worry
about having enough resources for future investments when making
this decision.
|
Definitely accept Please select one: projects A, D, and E projects A, B, and C projects B, C, and E projects A, B, and D projects B, C, and D projects A, B, and E. projects C, D, and E |
Solutions
Expert Solution
Profitability index is computed as shown below:
= Present value of future cash flows / Initial investment
If the PI of a project is greater than 1, it implies that the project's Present value of future cash flows is greater than the initial investment or in other words NPV is positive.
If the PI of a project is less than 1, it implies that the project's Present value of future cash flows is less than the initial investment or in other words NPV is negative.
If the PI of a project is equal to 1, it implies that the project's Present value of future cash flows is equal to the initial investment or in other words NPV is zero.
As can be seen the PI of Project A, B and C are greater than 1 which means that the NPV of all these projects are positive. Hence the correct answer is option of Project A, B and C.
Feel free to ask in case of any query relating to this question
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