E11-12 Ranking Capital Investment Projects Using Different Criteria [LO 11-2, 11
ID: 2591490 • Letter: E
Question
E11-12 Ranking Capital Investment Projects Using Different Criteria [LO 11-2, 11-3, 11-5, 11-6]
Jill Harrington, a manager at Jennings Company, is considering several potential capital investment projects. Data on these projects follow:
Required:
1. Compute the payback period for each project and rank order them based on this criterion. (Round your answers to 2 decimal places.)
2. Compute the NPV of each project and rank order them based on this criterion.
3. Compute the profitability index of each project and rank order them based on this criterion. (Round your answers to 2 decimal places.)
4. If Jennings has limited funds to invest, which ranking should Jill recommend?
Explanation / Answer
4. If Jennings had limited funds to invest, Jill would recommend NPV ranking as it is the most appropriate technique of making capital budgeting decisions. It takes into account time factor and hence analyses the cash flows on the basis of their present values.
DETAILS PROJECT X PROJECT Y PROJECT Z Initial Investment $40,000 $20,000 $50,000 Annual Cash Inflows 25,000 10,000 25,400 PV of cash inflows 45,000 33,000 70,000 1. Payback period = Initial Investment / Annual cash Inflows 40,000 / 25,000 = 1.6 years 20,000 / 10,000 = 2 years 50,000 / 25,400 = 1.96 years Ranking 1 3 2 2. NPV (PV of inflows - Outflows) 45,000 - 40,000 = $5,000 33,000 - 20,000 = $13,000 70,000 - 50,000 = $20,000 Ranking 3 2 1 3, Profitability Index = Pv of cash inlows / PV of cash outflows 45,000 / 40,000 = 1.125 33,000 / 20,000 = 1.65 70,000 / 50,000 = 1.40 Ranking 3 1 2 *------------*--------------*--------------*Related Questions
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