A firm is considering two capital investment projects. Project A involves an ini

Question

A firm is considering two capital investment projects. Project A involves an initial cost of $125,000. The discounted present value of all future cash flows is $145,000. Project B requires an initial expenditure of $85,000. The discounted present value of all future cash flows is $102,000.

(i) Calculate the net present value of each of the two projects. Which would be preferred according to the net present value criterion?

(ii) Calculate the profitability index of each of the two projects. Which would be preferred according to the profitability index criterion?

Explanation / Answer

a) NPv of project A = -125000+145000 = 20000

NPv of project B = -85000+102000 = 17000

Project A should be selected

b) profitability index of project A = 145000/125000 = 1.16

profitability index of project B = 102000/85000 = 1.2

Project B should be selected

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