19. The major advantage provided by the profitability index is it: A. provides a better measure of...

Free

50.1K

Verified Solution

Question

Finance

19. The major advantage provided by the profitability index isit:
A. provides a better measure of the effects of a project onshareholder wealth than NPV.
B. eliminates the need to estimate the firm's cost ofcapital.
C. is useful as an aid in ranking projects from best toworst.
D. reduces the forecast error of cash flow estimates.
E. is easier to calculate than NPV.

20. A firm has determined its cost of capital is 12.5%. It isconsidering three projects. Project F requires an initialinvestment of $25,000 with NPV of cash inflows equal to $35,000.Project G requires an initial investment of $50,000 with NPV ofcash inflows equal to $60,000. Project H requires an initialinvestment of $75,000 with NPV of cash inflows equal to $80,000.Which of the following statements is (are) correct? (x) All threeprojects are acceptable because the NPV of each project is greaterthan zero.
(y) The profitability index for all three projects is greater thanone but the profitability index for Project H is the largestbecause it requires the largest investment.
(z) Since the profitability index for Project F exceeds theprofitability index for Project G, the firm should pursue Project Fbefore it purses Project G.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only
E. (z) only

Answer & Explanation Solved by verified expert

3.8 Ratings (378 Votes)

19). Option C - Since profitability index is a ratio (relative measure), it can be used to rank projects from best to worst.

20). Profitability index = NPV of cash inflows/initial investment.

NPV = NPV of cash inflows - initial investment.

Project	Profitability index	NPV
F	1.40	10,000
G	1.20	10,000
H	1.07	5,000

Statement x is correct as all three projects have positive NPV and so, are acceptable.

Statement z is correct as profit from project F is more than from project G, project F should be pursued first.

(Option C is correct.)

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

19. The major advantage provided by the profitability index isit:A. provides a better measure of the effects of a project onshareholder wealth than NPV.B. eliminates the need to estimate the firm's cost ofcapital.C. is useful as an aid in ranking projects from best toworst.D. reduces the forecast error of cash flow estimates.E. is easier to calculate than NPV.20. A firm has determined its cost of capital is 12.5%. It isconsidering three projects. Project F requires an initialinvestment of $25,000 with NPV of cash inflows equal to $35,000.Project G requires an initial investment of $50,000 with NPV ofcash inflows equal to $60,000. Project H requires an initialinvestment of $75,000 with NPV of cash inflows equal to $80,000.Which of the following statements is (are) correct? (x) All threeprojects are acceptable because the NPV of each project is greaterthan zero.(y) The profitability index for all three projects is greater thanone but the profitability index for Project H is the largestbecause it requires the largest investment.(z) Since the profitability index for Project F exceeds theprofitability index for Project G, the firm should pursue Project Fbefore it purses Project G.A. (x), (y) and (z)B. (x) and (y) onlyC. (x) and (z) onlyD. (y) and (z) onlyE. (z) only