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.
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Tutor,
I refer to Bpp MCQ no 37.5.
NB Co is faced with an immediate capital constraint of $100 million available to invest.
It is considering investing in 4 divisible projects:$m Initial cost NPV
Project 1 40 4
Project 2 30 5
Project 3 50 6
Project 4 60 5What is the NPV generated from the optimum investment programme?
My question is this: why is it that (npv + initial cost) / initial cost was used to determine the profitability index instead of the regular formula: PV / initial cost?
Thank you
Ogo
It does not matter – there are two ways of defining it and either way will get the marks.
(and, of course, any decisions will be the same whichever definition you use)
John,
Thanks for your quick response…. I’ve tried it, the ranking is not the same, especially in MCQ the answer differs..
Kindly review Bpp revision kit, question no 37.5 ( NB Co) you will understand me better.
Thanks
Ogo
Of course the ranking is exactly the same – it always will be!!!
However I have just read again what you typed and it was wrong.
The normal formula is NPV / initial cost. In this question it gives 1) 0.10 ; 2) 0.17; 3) 0.12; 4) 0.08
The alternative is to use PV / initial cost. (Since NPV = PV – initial cost, then PV = NPV + initial cost). Using this (which is what BPP do here) gives 1) 1.10; 2) 1.17; 3) 1.12; 4) 1.08
The ranking remains the same. It always will – there is only one correct ranking!!
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