Jil Harrington, a manager at Jennings Company, is considering several potential

Question

Jil Harrington, a manager at Jennings Company, is considering several potential capital investment projects. Data on these projects follow: Project XProject Y Project z 40,000 $20,000 $50,000 25,000 10,000 45,000 33,000 Initial investment 25,400 PV of cash inflows Required 1. Compute the payback period for each project and rank order them based on this criterion. (Round your answers to 2 decimal places.) Payback Period Rank Project Y Project Z 2. Compute the NPV of each project and rank order them based on this criterion. NPV Rank

Explanation / Answer

Payback Period

In payback period we choose the last year where cumulative cash flows is negative..And then take the absolute value of cumulative cash flows and divide by next year's cash flows. So, Payback period=last year where cumulative cash flows is negative+cumulative cash flows/next year's cash inflows

Cumulative Cash flows in Year 0 for X:-40000

Cumulative Cash flows in Year 1 for X:-40000+25000=-15000

Cumulative Cash flows in Year 2 for X:-15000+25000=10000

Payback period for X: 1+15000/25000=1.6 years

Cumulative Cash flows in Year 0 for Y:-20000

Cumulative Cash flows in Year 1 for Y:-20000+10000=-10000

Cumulative Cash flows in Year 2 for Y:-10000+10000=0

Payback period for Y: 2 years

Cumulative Cash flows in Year 0 for Z:-50000

Cumulative Cash flows in Year 1 for Z:-50000+25400=-24600

Cumulative Cash flows in Year 2 for Z:-24600+25400=800

Payback period for Z: 1+24600/25400=1.97 years

The lower the payback, the better the project

hence, ranking: X:1, Z:2, Y:3

NPV

NPV=-Intial Investment+PV of Cash Inflows

NPV of X=-40000+45000=5000

NPV of Y=-20000+33000=13000

NPV of Z=-50000+70000=20000

Higher the npv the better the project

So, Rank will be Z:1, Y:2,X:3

Profitability Index

Profitability Index=1+NPV/Initial Investment

PI of X=1+5000/40000=1.125

PI of Y=1+13000/20000=1.65

PI of Z=1+20000/50000=1.4

Higher the PI the better the project

So, Rank will be Y:1, Z:2, X:3

In case of limited funds profitability index must be used as criterion for ranking

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