Exercise-5 (Present value index – ranking investment projects)

The management of National company is considering three competing investments – investment P, investment Q and investment R. The information about the requirement of initial amount of investment, present value of net cash inflow and net present value of all three investments is given below:

exercise-5-cbt-img1

Required:

Choose the most desirable proposal using present value index (profitability index).

Solution:

As each investment requires a different initial investment, the proposals would be ranked using present value index (also called profitability index).

Present value index = Present value of cash inflows/Initial investment

Proposal P: $36,000/$35,000 = 1.03

Proposal Q: $21,000/$20,000 = 1.05

Proposal R: $12,000/$11,000 = 1.09

Proposal R is the most desirable proposal because it has the highest present value index.

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3 Comments on Exercise-5 (Present value index – ranking investment projects)

  1. jeniffer

    Need help in calculating this quiz.
    angola company has six projects available for investment as follows.
    project initial cost sh’m’ [email protected] 15% cost of cap.
    1 60 21
    2 15 9
    3 20 9
    4 55 15
    5 30 20
    6 40 -2

    the firm has sh.100m available for investment. identify which project should be undertaken. using PI and NPV.

    1. Njohnny

      I am Jhonny Here is a comment about this exercise.

      If we divide the present value of future cash inflow by the initial investment, we would get the Present Value Index, so,
      Present value Index would be :
      1-: 60/ 21 =2.857
      2-: 15/ 9 =1.667
      3-: 20/ 9 =2.222
      4-: 55/ 15 =3.667
      5-: 30/ 20 =1.50
      6-: 40/ -2 =-20
      The proposal 4 would be the most desirable because of the highest present value index. or profitability index of 3.667. Which maybe higher than what the management foresaw.

      Now , the net present value would be : 55-15 =40.
      So according to the proposal 4, the Net Present Value is 40.

  2. Rohit

    PvP factor 20% Korma hoga
    31300 initial outlay h or invest amount 100000 h reply fast mera ‘kl paper h
    annual cash flow 6000 h

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