Question

Exercise 11-9 Preference Ranking of Investment Projects [LO11-3]

Oxford Company has limited funds available for investment and must ration the funds among four competing projects. Selected information on the four projects follows:

  

Project	Investment Required	Net Present Value	Life of the Project (years)	Internal Rate of Return (percent)
A	$900,000	$319,400	6	21%
B	$770,000	$464,050	11	22%
C	$750,000	$338,750	6	24%
D	$950,000	$207,050	4	20%

  

The net present values above have been computed using a 10% discount rate. The company wants your assistance in determining which project to accept first, second, and so forth.

  

Required:
1.	Compute the project profitability index for each project. (Round your answers to 2 decimal places.)

        

2.	In order of preference, rank the four projects in terms of net present value, project profitability index and internal rate of return.

     

Answer 1

(1) Computation of Profitability Index

PI= (NPV+ Initial Investment)/ Initial Investment

Project                Profitability Index

A             (900000+319400)/9000000= 1.35

B            (770000+464050)/770000 = 1.60

C            (750000+338750)/750000 = 1.45

D           (950000+207050)/950000 = 1.22

(2) Ranking of Project

The most economical project is given 1^st preference and thereafter lower rank

Ranking of Project on the basis of NPV

A higher NPV given 1^st preference then lower NPV

Project                 NPV                       Rank

A                             319400                  Third

B                             464050                  First

C                             338750                  Second

D                             207050                 fourth

Profitability Index: Ranking done using higher profitability index index 1^st rank and as so on

Project                 PI            Rank

A                             1.35        third

B                             1.60        First

C                             1.45        Second

D                             1.22        Fourth

Ranking of Project on the basis of IRR

An higher IRR is more desirable so given 1^st preference then lower IRR

Project                 IRR         Rank

A                             21%        Third

B                             22%        Second

C                             24%        First      

D                             20%        Fourth