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Preference Ranking of Investment Projects

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

Project 1 Project 2 Project 3 Project 4
Investment required $(270,000) $(450,000) $(360,000) $(480,000)
PV of cash flows at 10% 336,140 522,970 433,400 567,270
Net Present Value $ 66,140 $ 72,970 $ 73,400 $ 87,270
Life of project 6 years 3 years 12 years 6 years
Internal rate of return 18% 19% 14% 16%

The company's required rate of return is 10%; thus, a 10% 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:
a. Net present value
b. Project profitability index
c. Internal rate of return

3. Which ranking do you prefer? Why?

Solution Preview

1. Compute the project profitability index for each investment project.
Project Present Value of Inflows Initial Investment Profitability Index
1 $336,140 $270,000 1.25
2 $522,970 $450,000 1.16
3 $433,400 ...

Solution Summary

Given statistics on four projects, the solution illustrates how to compute each one's profitability index and how to rank them according to their net present values, project profitability indexes, and internal rates of return.

$2.19