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