Problem 5-17 Comparing Investment Criteria The treasurer of Amaro Canned Fruits,

Question

Problem 5-17 Comparing Investment Criteria

The treasurer of Amaro Canned Fruits, Inc., has projected the cash flows of projects A, B, and C as follows:

Compute the profitability index for each of the three projects. (Do not round intermediate calculations. Round your answers to 2 decimal places. (e.g., 32.16))

Compute the NPV for each of the three projects. (Do not round intermediate calculations. Round your answers to 2 decimal places. (e.g., 32.16))

Suppose these three projects are independent. Which project(s) should Amaro accept based on the profitability index rule?

Suppose these three projects are mutually exclusive. Which project(s) should Amaro accept based on the profitability index rule?

Suppose Amaros budget for these projects is $520,000. The projects are not divisible. Which project(s) should Amaro accept?

The treasurer of Amaro Canned Fruits, Inc., has projected the cash flows of projects A, B, and C as follows:

Explanation / Answer

step1:

calculate Present value of cash flows(PV) starting from year 1

PV of Project A = 145000/(1+12%) + 145000/(1+12%)^2   = 245057.397959

PV of Project B= 238000/(1+12%) + 238000/(1+12%)^2 =   402232.142857

PV of Project C = 155000/(1+12%) + 125000/(1+12%)^2 = 238042.091837

step2:

a)

profitability index(PI) = PV of cash flows from year 1 / initial investment

Initial investment is the negative cash flow in year 0

PI of Project A = 245057.397959/195000 = 1.26

PI of Project B = 402232.142857/325000 = 1.24

PI of Project C = 238042.091837/195000 = 1.22

step3:

b)

NPV = PV of cash flows from year 1- initial investment

NPV of Project A = 245057.397959 - 195000 = $50,057.40

NPV of Project B = 402232.142857 - 325000 = $77,232.14

NPV of Project C = 238042.091837 - 195000 = $43,042.09

C)

Amaro should accept Project A ,Project B and Project C sinceprofitability index of all the projects is greater than 1

d)

Amaro should accept Project A, since its profitability index is highest

e)

Amaro should accept Project A and Project B , since both have profitabality higher than the project C and he has o more money left to invest in Project C

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