A company seeking investment opportunities has collected the following information:Project AProject BProject CProject DInitial
investment$400,000$250,000$150,000$270,000PV of cash inflows$570,000$295,000$210,000$282,000Payback period (years)3.63.04.753.5NPV of project$170,000$45,000$60,000$12,000Profitability index1.431.181.401.04If the company makes a decision based on the net present value, which project will be selected?
1 answer:
Answer:
Project C
Explanation:
If we make the decision based on the net present value (NPV) then we will choose the project that has the greatest NPV.
NPV is the sum of the present value of project´s cash flows. To have the present value of a cash flow (inflows and outflows) we use a discount rate and the year of the cash flow (the formula is attached).
When we have al cash flows in present value, we sum them including the investment (which is most of the time negative and it is in present value so we don´t have to transform it). This is the NPV (formula attached).
If the NPV is greater than cero, then the project is creating value, the investors will recover the investment and will have profits. So if the NPV of project is greater than the NPV of another, that project is creating more value.
You might be interested in