This information is pertaining to the cash flows of three mutually exclusive inv

Question

This information is pertaining to the cash flows of three mutually exclusive investment proposals:

Proposal A Proposal B Proposal C

Initial Investment 60,000 60,000 60,000

Cash flow from operations

Year 1 50,000 30,000 60,000

Year 2 6,000 30,000

Year 3 29,000 25,000

Disinvestments 0 0 0

Life (Years) 3yrs 3yrs 1yr

Assume that the organization's cost of capital is 12 percent. Calculate the NPV and Profitability Index for each of the three proposals. Explain which proposal would be best based on the profitability indexes.

Explanation / Answer

Profitability index = Present value /initial investment

A = 70067.76/60000 = 1.17

B= 68496/60000 = 1.14

C= 53571.6/60000= .89

Base on profitability index ,Proposal A should be selected as it has highest profitability index .

year Proposal A Proposal B Proposal   C cash flow PVF 12% Present value of cash flow [CF *PVF] Cash flow PVF 12% Present value of cash flow cash flow PVF 12% Present value of cash flow 1 50000 .89286 44643 30000 .89286 26785.8 60000 .89286 53571.6 2 6000 .79719 4783.14 30000 .79719 23915.7 0 .79719 0 3 29000 .71178 20641.62 25000 .71178 17794.5 0 .71178 0 present value of cash flow 70067.76 68496 53571.6 less:Initial investment (60000) (60000) (60000) Net present value 10067.76 8496 -6428.4

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