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Hi Sir,
I have doubt in June 2014 question 1 (b)
My PI’s does not match with the examiner’s answers.
why did he divide PV of future cash flows/Investment…Shouldn’t it be NPV/Investment?Both ways are valid for the marks, and both ways end up giving the same ranking.
Project A: 1,000,000/2,500,000=0.40 rank 3
B: 1,550,000/2,200,000=0.70 (rank D has higher PI so this is ignored as its mutually exclusive)
C: 1,350,000/2,600,000=0.52 rank 2
D: 1,500,000/1,900,000=0.79 rank 1
E: 0/5,000,000= 0 rank 4Funds 10,000,000. NPV
D (1,900,000) 1,500,000
8,100,000
C(2,600,000). 1,350,000
5,500,000
A (2,500,000). 1,000,000
3,000000
E 60% of 3,000,000. 0
Max NPV 3,850,000Can you tell me where have I gone wrong
The question says that E is strategically important and must be undertaken.
Therefore you should take all of E and then consider how the remaining capital should be invested.
(Incidentally you can find lectures working through the whole of this exam if you go to the “Revision Kit Live” link from the main F9 page on this website.)
Oops – you are correct. I was mistaken.
However, I have answered your original query.
John,
Regarding June 2014 Q1 (b). Sorry if I’m doing this wrong by replying to an older post, but I am confused as to why the examiner has aggregated the costs of the initial investments and their NPVs and described the resulting amount as “PV of future cash flows” before calculating the profitability index. It seems to me that the initial investment is not a future cash flow, and certainly not an inward cash flow. I appreciate your point above that the same rankings will result from just dividing the NPVs by the initial investments, but conceptually this has me flummoxed.
I would be grateful if you could throw a bit of light on the examiner’s reasoning here.
Thanks and my compliments to you and your website, both outstanding 🙂
James
Here is a simple example:
If the NPV is 100, then this is the PV of the future flows less the initial investment.
If the initial investment is 200, then it means that the PV of the future flows is 300. (300 – 200 = 100)For the profitability index the examiner is not consistent – you either take the NPV per $ invested or the PV per $ invested. The ranking will be the same and this is all the matters for the exam.
Thank you, John. I suppose I should have guessed at that myself, since it is so obvious once explained!! Sometimes you just have to take a breath and think about it logically, although that’s not always so easy when time pressure is on before an exam 🙂
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