ExpertMedium2 marksMultiple Choice
ACCA · Question 8 · Investment Appraisal
Section A
Oceanic Minerals is considering several deep-sea mining projects but faces strict capital rationing. The company has $10 million available.
Project Alpha requires an initial investment of $4m and has an NPV of $1.2m.
Project Beta requires an initial investment of $6m and has an NPV of $1.5m.
Project Gamma requires an initial investment of $5m and has an NPV of $1.6m.
Assuming the projects are divisible, what is the Profitability Index (PI) of Project Gamma?
Section A
Oceanic Minerals is considering several deep-sea mining projects but faces strict capital rationing. The company has $10 million available.
Project Alpha requires an initial investment of $4m and has an NPV of $1.2m.
Project Beta requires an initial investment of $6m and has an NPV of $1.5m.
Project Gamma requires an initial investment of $5m and has an NPV of $1.6m.
Assuming the projects are divisible, what is the Profitability Index (PI) of Project Gamma?
Answer options:
A.
0.32
B.
1.25
C.
1.32
D.
3.125
How to approach this question
Calculate the Profitability Index using the formula: PI = Present Value of Future Cash Flows / Initial Investment. Alternatively, PI = 1 + (NPV / Initial Investment).
Full Answer
C.1.32✓ Correct
The Profitability Index (PI) measures the present value of returns per dollar invested.
PV of future cash flows for Gamma = Initial Investment + NPV = $5m + $1.6m = $6.6m.
PI = $6.6m / $5m = 1.32.
(Alternatively, PI = 1 + (1.6/5) = 1.32).
Common mistakes
Calculating NPV / Initial Investment (0.32) and stopping there. While 0.32 is used for ranking, the formal PI is 1.32.
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