Multiple Choice QuestionA company needs to choose between two investment opportunities. Project 1 has a cost of $500,000 and expected NPV of cash flows of $450,000. Project 2 has a cost of $800,000 and expected NPV of cash flows of $750,000. Using profitability index as the evaluation method, the company should choose:Multiple choice question.either project. Both are acceptable because the difference between cost and NPV is $50,000 for bothProject 2 because it has a higher NPVProject 1 because it has a higher indexProject 2 because it has a higher index
Question
Multiple Choice QuestionA company needs to choose between two investment opportunities. Project 1 has a cost of 450,000. Project 2 has a cost of 750,000. Using profitability index as the evaluation method, the company should choose:Multiple choice question.either project. Both are acceptable because the difference between cost and NPV is $50,000 for bothProject 2 because it has a higher NPVProject 1 because it has a higher indexProject 2 because it has a higher index
Solution 1
The profitability index is calculated by dividing the present value of future cash flows by the initial investment cost.
For Project 1, the profitability index would be 500,000 = 0.9.
For Project 2, the profitability index would be 800,000 = 0.9375.
Therefore, using the profitability index as the evaluation method, the company should choose Project 2 because it has a higher index.
Solution 2
The profitability index (PI) is a financial metric that is widely used in capital budgeting. It's calculated by dividing the present value of future cash flows by the initial investment cost.
For Project 1, the PI would be 500,000 = 0.9.
For Project 2, the PI would be 800,000 = 0.9375.
Therefore, the company should choose Project 2 because it has a higher profitability index.
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