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2) A NPV of 2 zero implies that an investments

A) IRR is greater than the firms required rate of return

B) Present value of cash inflows exceeds the investments cost

C) Present value of cash inflows is positive

D) Cost exceeds the present value of its cash inflows

E) Cost is equal to the present value of its cash inflows

3) In comparing two projects using NPV profile, at the point where the net present values of the

project are equal, _________________.

A) the interest rate that makes them equal is called the crossover rate

B) the projects both have NPVs equal zero

C) the IRR of each is equal to zero

D) the IRR of each is equal to the cost of capital

E) the IRR exceed the cost of capital

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4) You are considering the following projects but you have limited funds to invest and cant take

them all. Using the profitability index, rank the projects in the order in which you would

accept them.(i.e. rank them from best to worst) Note that NONE of them are mutually

exclusive projects.

Initial investment NPVProject A RM100, 000 RM30, 000

Project B RM 80,000 RM25, 000

Project C RM 40,000 RM17, 000

Profitability Index Decision Rules

Independent Projects

Accept Project if PI 1

Mutually Exclusive Projects

Accept Highest PI 1 Project

A) A,B,C

B) B,A,C

C) C,B,A

D) B,C,A

E) A,C,B

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Profitability index Project A

= RM100, 000 + RM30, 000

RM100, 000

= 1.3

Profitability index Project B

= RM 80,000 - RM25, 000

RM 80,000

= 1.31

Profitability index = Initial investment + NPV

Initial investment

Profitability index Project B

= RM 40,000 RM17, 000

RM 40,000

= 1.46

PI Project A = 1.3

PI Project B = 1.31

PI Project C = 1.48

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5) ACME Sdn. Bhd. will invest RM110, 000 in a project that will produce the following cash

flows. The cost of capital is 11%. Should the project be undertaken? Give reasons.

(Note that the fourth years cash flow is negative)

Cash Flow (RM)Year 1 36,000

Year 2 44,000

Year 3 38,000

Year 4 -44,000

Year 5 81,000

Payback Period

1 st year = -110, 000 + 36, 000 = -74, 000

2nd year = -74, 000 + 44, 000 = -30, 000

3 rd year = -30, 000 + 38. 000 = 8, 000

PP of project = 2 + (110, 000 80, 000) / (118, 000 80, 000)

= 2.78 years

NPV = 36, 000 + 44,000 + 38, 000 + (-44, 000) + 81, 000 110, 000

(1.11) (1.11) (1.11) (1.11) (1.11)

= 32, 432 + 35, 711+ 27, 785 28, 984+ 48, 070 110, 000

= RM 5, 014

Profitability Index

= 110, 000 + 5, 014

110, 000

= 1.05

The project should be undertaken because:

Payback period is not to long

NPV promise a return greater than the required rate of return

The Profitability Index > 1 so the project is acceptable

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