Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 61

Calculate NPV—rank projects using present value ratios The following capital expenditure projects have been proposed for management’s consideration at Heard, Inc., for the upcoming budget year:

				Project
	Year(s)	A	B	C	D	E
Initial
investment.	0	$(50,000)	$(50,000)	$(1 00,000)	$(100,000)	$(200,000)
Amount of
net cash return . .	1	10,000	0	32,000	10,000	60,000
	2	10,000	0	32,000	20,000	60,000
	3	10,000	20,000	32,000	30,000	30,000
	4	10,000	20,000	32,000	40,000	30,000
	5	10,000	20,000	32.000	50,000	30,000
Per year	6-10	10,000	12,000	0	0	30,000
NPV (14% discount rate)		$ 2,161	$          ?	$       ?	$          ?	$ 5,884
Present value ratio		1.04	?	?	?	?

Required:

a. Calculate the net present value of projects B, C, and D, using 14% as the cost of capital for Heard, Inc.

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b. Calculate the present value ratio for projects B, C, D, and E.

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c. Which projects would you recommend for investment if the cost of capital is 14% and

1. $100,000 is available for investment?

2. $300,000 is available for investment?

3. $500,000 is available for investment?

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d. What additional factors (beyond those considered in parts a-c might influence your project rankings?

Step 1 of 6

Compute NPV – rank projects on the basis of profitability index

Net present value (NPV): NPV is the distinction in terms of present value between the cash inflows and cash outflows.

Present value ratio or profitability index (PI): It shows the present value of inflows in proportion to the present value of investment or cash outflows.