Question

Eddie Corporation is considering the following three investment projects (Ignore income taxes.):

Project C Project D Project E
Investment required

$ 68,400 $ 77,900 $ 161,500
Present value of cash inflows

$ 75,924 $ 90,364 $ 176,035

Rank the projects according to the profitability index, from most profitable to least profitable.


Investment required-Present value of cash inflows
=Net present value
-->
Net present value / Investment required
=Project profitability index

Answer 1

To rank the projects by profitability index, we calculate this index as the net present value divided by the investment required for each project. Project D has the highest profitability index, followed by Project C and then Project E. Hence, Project D is the most profitable investment.

Step-by-step explanation:

The student is asking how to rank three investment projects (Project C, Project D, Project E) according to their profitability index. The profitability index is a ratio of the present value of cash inflows to the investment required. To calculate it, we need to subtract the investment required from the present value of cash inflows to find the net present value (NPV) and then divide that NPV by the investment required.

For Project C: Profitability Index = (75,924 - 68,400) / 68,400 = 1.110

For Project D: Profitability Index = (90,364 - 77,900) / 77,900 = 1.160

For Project E: Profitability Index = (176,035 - 161,500) / 161,500 = 1.090

Ranking these from most profitable to least profitable gives us:

1. Project D
2. Project C
3. Project E