Carmen, Inc., which has a hurdle rate of 10%, is considering three different independent investment opportunities. Each project has a five-year life. The annual cash flows and initial investment for each of the projects are as follows: Project A Project B Project C Annual cash flows$79,150 $65,950 $72,540 Initial investment 150,000 105,000 140,000 a. What is the present value of the annual cash flows for each of the three projects?b. What is the net present value of each of the projects?c. What is the profitability index of each of the projects? (Round to two decimal places.)d. In what order should Carmen prioritize investment in the projects?

Question

What will be an ideal response?

Answer 1

a. A $300,042 = $79,150 × 3.7908; B $250,003 = $65,950 × 3.7908; C $274,985 = $72,540 × 3.7908
 b. A $150,042 = $300,042 ? $150,000; B $145,003 = $250,003 ? $105,000; C $134,985 = $274,985 ? $140,000
 c. A 2.00 = $300,042/$150,000; B 2.38 = $250,003/105,000; C 1.96 = $274,985/$140,000
 d. B, A, C
 
Net present value is calculated by discounting the annual cash flows and subtracting the initial investment. Profitability index = Present value of future cash flows/Initial investment. Investment in projects should be prioritized by their profitability indexes. The higher the indexed amount, the better the investment.