6.A firm is considering three investment projects. Estimates of the post-investm
ID: 2775928 • Letter: 6
Question
6.A firm is considering three investment projects. Estimates of the post-investment values of selected financial data are shown below.
Project 1
Net income = 20,000,000
Revenues = 100,000,000
P/E ratio = 25
Expenses = 80,000,000
Outstanding shares = 15,000,000
Project 2
Net income = 28,000,000
Revenues = 250,000,000
P/E ratio = 15
Expenses = 222,000,000
Outstanding shares = 12,000,000
Project 3
Net income = 80,000,000
Revenues = 680,000,000
P/E ratio = 21
Expenses = 600,000,000
Outstanding shares = 50,000,000
Which project or projects should the firm select? Why
Explanation / Answer
I will select that Project. Whose Market Price Per share (MPS) is Higher.
MPS is calculated by following Formulae = P/E Ratio * Earnings per share (EPS)
Project 1
EPS = Net income / Number of shares
= 2000000 / 1500000 = 1.33
(Market price per share) MPS = 1.33 * 25 = 33.33
Project 2
EPS = 2800000 /1200000 = 2.33
Market price per share (MPS) = 2.33 * 15 = 35 (approx)
Project 3
EPS = 8000000 / 5000000 = 1.6
Market price per share (MPS) = 1.6 * 21 = 33.6
Conclusion :- Project 2 Having Higher (Market price per share) MPS of 35 is selected.
Alternate Solution:- if You take Market Capitalization as a base / criteria for selecting the project. then it is also a decent criteria. Decision may accordingly vary from my above solution, but both are appropriate soltions. According to this, Project having Highest Market Capitalization is selected.
Market Capitalization = Market price per share * Number of Shares
Project 1 = 1500000 * 33.33 = 50000000 (approx)
Project 2 = 1200000 * 35 = 42000000
Project 3 = 5000000 * 33.6 = 168000000
So. Project 3 is selected, as having highest market capitalization.
Note:- Market Price per share (MPS) is better criteria than Market Capitalizatization in this question, as the number of shares are different in each Three projects.
So as Per (Market price per share) MPS approach, Project 2 is to be selected in my opinion. This is Final.
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