Project Net InvestmentNPV PV Of Future Cash flows Profitability IndexRank J $ 250,000.00 $ 35,000.00 $ 285,000.001.141F $ 250,000.00 $ 30,000.00 $ 280,000.001.122A $ 200,000.00 $ 22,000.00 $ 222,000.001.113H $ 200,000.00 $ 18,000.00 $ 218,000.001.094E $ 500,000.00 $ 40,000.00 $ 540,000.001.085B $ 275,000.00 $ 21,000.00 $ 296,000.001.086G $ 100,000.00 $ 7,000.00 $ 107,000.001.077C $ 150,000.00 $ 6,000.00 $ 156,000.001.048I $ 210,000.00 $ 4,000.00 $ 214,000.001.029D $ 190,000.00 $ (19,000.00) $ 171,000.000.9010
1)The projects that should be accepted are J,F,A,H,B. All of these have the top 5 profitability index’s except B, but needs to be chosen due to the capital limit that the company has to spend. If we were to include E then they would go over the $1.2M limit that was set.
2)When ranking by the NPV the projects that should be chosen are E,J,F,A due to the fact they have the highest NPV, but also fit into the $1.2M capital budget.
3) If the investment funds are reduced to $1M then we would have to exclude project A because the initial investment would cause them to go over the allotted capital. The opportunity cost of the eliminated amount would be the $22,000 NPV.
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:
Allocation of funds requires ranking investment alternatives to make the best financial decision for the business. The process of ranking is essential in capital budgeting, which is the process of examining various projects to determine the profits and cost associated with each individual project to assist in choosing the most beneficial (Schneider, 2017). In Grosvenor Industries there are ten projects to evaluate and rank.
Rank the projects using the profitability index. Considering the limit on funds available, which projects should be accepted?
According to Schneider (2017), “ a profitability index is found by dividing the present value of a project’s net cash inflows by its net initial investment” (p. 420). The higher the profitability index ratio the greater the probability the investment has to positively produce therefore the more appealing the project is compared to others. Acceptable ratios are at least 1 or greater (Schneider, 2017). Considering the limits on funds the following Grosvenor Industries should accept the following projects; Projects J, F, A and H as these projects have the greatest ratios above 1.
RANKPROJECTNET PRESENT VALUEINITIAL INVESTMENT NPVPROFIT INDEX3A.222,000200,00022,0001.1106B.296,000275,00021,0001.0768C.156,000150,0006,0001.04010D.171,000190,000(19,000)0.9005E.540,000500,00040,0001.0802F.280,000250,00030,0001.1207G.107,000100,0007,0001.1204H.218,000200,00018,0001.0909I.214,000210,0004,0001.0191J.285,000250,00035,0001.140
Using the NPV, which projects should be accepted, considering the limit on funds available?
If solely using the NPV to determine which projects should be accepted, Projects E, J, F, A, yield the highest NPV.
RANKPROJECTNET PRESENT VALUEINITIAL INVESTMENT NPVPROFIT INDEX4A.222,000200,00022,0001.1105B.296,000275,00021,0001.0768C.156,000150,0006,0001.04010D.171,000190,000(19,000)0.9001E.540,000500,00040,0001.0803F.280,000250,00030,0001.1207G.107,000100,0007,0001.1206H.218,000200,00018,0001.0909I.214,000210,0004,0001.0192J.285,000250,00035,0001.140
If the available investment funds are reduced to only $1,000,000:
Does the list of accepted projects change from Part 2?
If the investment funds were reduced from $1.2 million to $1 million that the accepted projects from Part 2 would need to be changed. Projects E, F, and J would continue to be acceptable, however Project A would essentially be eliminated as it exceeds the investment funds available.
What is the opportunity cost of the eliminated $200,000?
The elimination of the opportunity cost ultimately decreases the number of projects Grosvenor Industries is financially able to consider and undertake. Therefore, the opportunity cost would equate to $22,000 if the $200,000 were eliminated due to Project A’s NPV.
Schneider, A. (2017). Managerial Accounting: Decision making for the service and manufacturing sectors (2nd ed.) [Electronic version]. Retrieved from https://content.ashford.edu/