Part Three

Present Value Index

When funds for capital investments are limited, projects can be ranked using a present value index. A project with a negative net present value will have a present value index below 1.0. Also, it is important to note that a project with the largest net present value may, in fact, return a lower present value per dollar invested.

Let's look at an example of how to determine the present value index.

The company has a project with a 5-year life, an initial investment of $195,000, and is expected to yield annual cash flows of $55,500. Whathat is the present value index of the project if the required rate of return is set at 8%?

Present value index	=	Total present value of net cash flows
Initial investment

Calculation Steps

Note: Round total present value of net cash flows and initial investment to nearest dollar. Round present value index to two decimal places.

Present value index =		=