Logan Company is considering two projects, A and B. The following information ha

Question

Logan Company is considering two projects, A and B. The following information has been gathered on these projects:
Initial investment needed; Project A = $40,000, Project B = $60,000
Present value of future cash flows; Project A = 60,000, Project B = 85,000
Useful life; Project A = 4 years, Project B = 4 years

Based on this information, which of the following statements is (are) true?

Statement I. Project A has the highest ranking according to the profitability index criterion.
Statement II. Project B has the highest ranking according to the net present value criterion.
1) Only I.
2) Only II.
3) Both I and II.
4) Neither I nor II.

Explanation / Answer

NPV of Project = Present value of Future Cash Flows - Initial Investment NPV of Project A = 60,000 - 40,000 = $20,000 NPV of Project B = 85,000 - 60,000 = $25,000 Since the projects are of equal useful life lengths, direct comparison of the NPV can be made Profitablility Index = (NPV + Initial Investment)/ Initial Investment Profitability Index of Project A = (20,000 + 40,000)/40,000 = 1.5 Profitability Index of Project B = (25,000 + 60,000)/60,000 = 1.42 Therefore Ans is 3) Both I and II

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