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June’14 q-1
The Board of OAP Co has decided to limit investment funds to $10 million for the next year and is preparing its capital
budget. The company is considering five projects, as follows:
Initial investment Net present value
Project A $2,500,000 $1,000,000
Project B $2,200,000 $1,550,000
Project C $2,600,000 $1,350,000
Project D $1,900,000 $1,500,000
Project E $5,000,000 $(46,000)
All five projects have a project life of four years. Projects A, B, C and D are divisible, and Projects B and D are mutually
exclusive. All net present values are in nominal, after-tax terms.b) Calculate the maximum net present value which can be obtained from investing the fund of $10 million,
assuming here that the nominal after-tax NPV of Project E is zero?Note:- my question is here, if the npv zero then profitibilty index for this project also b zero , as P.I=npv/investment,
then how it is ranked as no 1 , when PI=0?It is because the question says that Project E is strategically important and must be undertaken, regardless of its financial acceptability.
So even if the NPV of E was negative it would still have to be undertaken. So it is only the rest of the cash available that needs to be invested in the others (ranked by profitability index).
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