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BUS 630 Week 5 DQ 2 Ranking Investment Alternatives

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Accounting

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BUS 630 Week 5 DQ 2 Ranking Investment
Alternatives
Grosvenor Industries has designated $1.2 million for capital
investment expenditures during the upcoming year. Its cost of capital
is 14 percent. Any unused funds will earn the cost of capital rate. The
following investment opportunities along with their required
investment and estimated net present values have been identified:
Project Net Investment NPV Project Net Investment
NPV
A $200,000 $22,000 F $250,000 $30,000
B 275,000 21,000 G 100,000 7,000
C 150,000 6,000 H 200,000
18,000
D 190,000 (19,000) I 210,000 4,000
E 500,000 40,000 J 250,000
35,000
In your response, complete the following:

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1. Rank the projects using the profitability index. Considering the limit
on funds available, which projects should be accepted?
Solution:
Profitability index = PV of cash inflows / Net investment
= (NPV + Net investment) / Net investment
PI of Project A = ($22,000 + 200,000) / $200,000
= 1.11
Likewise, PI of other projects:
Project Investment NPV PI Ranking
A $200,000 $22,000 1.11 3
B 275,000 21,000 1.08 5
C 150,000 6,000 1.04 7
D 190,000 -19,000 0.90 9
E 500,000 40,000 1.08 5
F 250,000 30,000 1.12 2
G 100,000 7,000 1.07 6
H 200,000 18,000 1.09 4
I 210,000 4,000 1.02 8
J 250,000 35,000 1.14 1
Limit on capital expenditure = $1,200,000
Projects that should be accepted = J, F, A, H and B

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Total capital investment = $250,000 + 250,000 + 200,000 + 200,000 +
275,000 = $1,175,000
2. Using the NPV, which projects should be accepted, considering the
limit on funds available?
Solution:
According to NPV approach, Project with the highest NPV is selected
first as it would maximize the shareholder’s wealth highest.
Projects that should be accepted = E, J, F and A
Total capital investment = $500,000 + 250,000 + 250,000 + 200,000 =
$1,200,000
Increase in shareholder’s wealth = $40,000 + 35,000 + 30,000 +
22,000 = $127,000
3. If the available investment funds are reduced to only $1,000,000:
(a) Does the list of accepted projects change from Part 2?
Solution:
Yes, the list of accepted projects would change.
Projects that should be accepted = E, J and F

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