Simmons Investment Group (SIG) used Excel to determine the net present value, th

Question

Simmons Investment Group (SIG) used Excel to determine the net present value, the present value index, and the internal rate of return of two investment alternatives. A summary of the results is shown below:

SIG has $430,000 to invest. Assuming there are no other investment opportunities available, SIG should

a. invest in Alternative 1 because it has a higher net present value.

b. invest in Alternative 2 because it has a higher internal rate of return.

c. invest in Alternative 1 because the cost of the investment is higher.

d. invest in Alternative 2 because the cost of the investment is lower.

Alternative 1 Alternative 2   Cost of the investment $ 426,000   Cost of the Investment $ 311,000   Net Present Value (NPV) $    11,120   Net Present Value (NPV) $ 9,450   Present Value Index 1.27   Present Value Index (NPV) 1.32   Internal Rate of Return (IRR) 10%   Internal Rate of Return (IRR) 11%

SIG has $430,000 to invest. Assuming there are no other investment opportunities available, SIG should

a. invest in Alternative 1 because it has a higher net present value.

b. invest in Alternative 2 because it has a higher internal rate of return.

c. invest in Alternative 1 because the cost of the investment is higher.

d. invest in Alternative 2 because the cost of the investment is lower.

Explanation / Answer

a. invest in Alternative 1 because it has a higher net present value. This is because company does not have any other investment oppurtunity available This would means that the funds left after making investment will be kept idle and they will not generate any return i.e. NPV of idle funds is nil. Thus NPV should be preferred over IRR methods and Profitability Index as there are no alternative use of the funds and they wil be kept idle. Thus we should invest in Alternative 1 as it will provide maximum benefit

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