Present Value Index

When funds for capital investments are limited, projects can be ranked using apresent 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 $220,000, and is expected to yield annual cash flows of $55,000. Whathat is the present value index of the project if the required rate of return is set at 10%?

Present value index = Total present value of net cash flows

Initial investment

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= $___________

$220,000 = _____________

McCall Corporation is looking to invest in Project A or Project B. The data surrounding each project is provided below. McCall's cost of capital is 11%.

Project A

This project requires an initial investment of $172,500. The project will have a life of 6 years. Annual revenues associated with the project will be $130,000andexpenses associated with the project will be $35,000.

Project B

This project requires an initial investment of $172,500. The project will have a life of 6 years. Annual revenues associated with the project will be $130,000andexpenses associated with the project will be $35,000.This project requires an initial investment of $130,000. The project will have a life of 4 years. Annual revenues associated with the project will be $111,000andexpenses associated with the project will be $60,000.

Calculate thenet present valueand thepresent value indexfor each project using the present value tables provided below.

Present Value of $1 (a single sum) at Compound Interest.

Present Value of an Annuity of $1 at Compound Interest.

Note:Use a minus sign to indicate a negative NPV.If an amount is zero, enter "0".Enter the present value index to 2 decimals.

Project A Project B

Total present value of net cash flow $_________ $_________

Amount to be invested 172,5000 130,000

Net present value $_________ $_________

Present value index:

Project A ________

Project B _________

The McCall purchasing department has made revisions to their costs and annual cash flows for Project A and Project B, as outlined below.

Project A

Project A's revised investment is $214,000. The project's life and cash flow have changed to 5 years and $55,000, respectively, while expenses have been eliminated.

Project B

Project A's revised investment is $214,000. The project's life and cash flow have changed to 5 years and $55,000, respectively, while expenses have been eliminated.Project B's revised investment is $150,200. The project's life and cash flow have changed to 6 years and $87,500 while expenses reduced slightly to $55,000.

Compute the internal rate of return factor for Project A and Project B and then identify each project's corresponding percentage from the PV ordinary annuity table.

Note: Enter the IRR factor, to 5 decimal places.

Project A: The calculated IRR factor is___________ and this value corresponds to which percentage in the present value of ordinary annuity table?_________%

Project B: The calculated IRR factor is________ and this value corresponds to which percentage in the present value of ordinary annuity table?

___________%