(Problem 10-41) Grosvenor Industries has designated $1.2 million for capital inv

Question

(Problem 10-41) Grosvenor Industries has designated $1.2 million for capital investment expenditures during the upcoming year.  Its cost of capital is 14 percent.  Any unused funds will earn the cost of capital rate.  The following investment opportunities along with their required investment and estimated net present values have been identified:

Project           Net Investment             NPV               Project     Net Investment                NPV  

            A             $200,000                 $22,000                  F             $250,000                 $30,000

            B               275,000                   21,000                 G              100,000                     7,000

            C               150,000                     6,000                 H              200,000                   18,000

            D               190,000                  (19,000)                I               210,000                     4,000

            E                500,000                    40,000                J              250,000                   35,000

In your response, complete the following:

1.  Rank the projects using the profitability index.  Considering the limit on funds available, which projects should be accepted?

2.  Using the NPV, which projects should be accepted, considering the limit on funds available?

3.  If the available investment funds are reduced to only $1,000,000:

            (a)        Does the list of accepted projects change from Part 2?

            (b)        What is the opportunity cost of the eliminated $200,000

Explanation / Answer

Profitability index = PV of cash inflows / Net investment
= (NPV + Net investment) / Net investment
PI of Project A = ($22,000 + 200,000) / $200,000
= 1.11

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