Capital Invest, Inc. uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming year: Project 1 Project 2 Project 3 Project 4
Initial capital outlay $200,000 $298,000 $248,000 $272,000
Annual cash inflows:
Year 1 $65,000 $100,000 $880,000 $95,000
Year 2 70,000 135,000 95,000 125,000
Year 3 80,000 90,000 90,000 90,000
Year 4 40,000 65,000 80,000 60,000
Net present value (3,789)4,276 14,064 14,662
Profitability Index 0.98 1.01 1.06 1.05
Internal rate of return 11% 13% 14% 15%
(CMA)Which projects should Capital Invest, Inc. undertake during the upcoming year assuming it has no budget restrictions?

Question

Quizplus · Accepted Answer

Capital Invest, Inc. should undertake Projects 2, 3, and 4 because they all have a profitability index greater than 1.0, indicating that they will generate value for the company. Project 1 has a profitability index less than 1.0, indicating that it will not generate sufficient value for the company. While Project 1 has a positive net present value, it still falls below the company's 12% hurdle rate. Therefore, Projects 2, 3, and 4 have a higher priority for investment than Project 1.