Consider the following projects, for a firm using a discount rate of 10%:
project NPV IRR PI
A $200,000 12.2% 1.04
B $200,001 11% 1.01
C $60,000 10.1% 1.61
D $(235,000) 9% .95
If the projects are independent, which, if any, project(s) should the firm accept?
a. Project A
b. Project B
c. Project D
d. Projects B and D
e. Projects A, B and C
To determine which project(s) the firm should accept, we can compare the metrics of each project against certain criteria.
1. Net Present Value (NPV): The NPV measures the profitability of a project by calculating the present value of its expected cash flows. A positive NPV indicates that the project is expected to generate value.
2. Internal Rate of Return (IRR): The IRR is the discount rate at which the NPV of a project becomes zero. It represents the project's average annual rate of return.
3. Profitability Index (PI): The PI compares the present value of a project's cash inflows to the present value of its cash outflows. A PI greater than 1 indicates that the project is expected to be profitable.
Let's evaluate each project against these criteria:
Project A:
- NPV: $200,000 (positive)
- IRR: 12.2% (greater than the discount rate)
- PI: 1.04 (greater than 1)
Project B:
- NPV: $200,001 (positive)
- IRR: 11% (greater than the discount rate)
- PI: 1.01 (greater than 1)
Project C:
- NPV: $60,000 (positive)
- IRR: 10.1% (greater than the discount rate)
- PI: 1.61 (greater than 1)
Project D:
- NPV: $(235,000) (negative)
- IRR: 9% (less than the discount rate)
- PI: 0.95 (less than 1)
Based on these evaluations, the firm should accept projects with positive NPV, IRR greater than the discount rate, and PI greater than 1.
Therefore, the firm should accept projects A, B, and C. The correct option out of the given choices (a, b, c, d, and e) is e. Projects A, B, and C.