ExpertMedium2 marksMultiple Choice
ACCA · Question 11 · Investment Appraisal
Section A
BioGenix is facing single-period capital rationing. It has $5m available to invest and is considering four divisible projects.
Project A: Outlay $2m, NPV $0.6m
Project B: Outlay $3m, NPV $1.2m
Project C: Outlay $1.5m, NPV $0.5m
Project D: Outlay $2.5m, NPV $0.8m
In what order should the projects be ranked to maximize NPV?
Section A
BioGenix is facing single-period capital rationing. It has $5m available to invest and is considering four divisible projects.
Project A: Outlay $2m, NPV $0.6m
Project B: Outlay $3m, NPV $1.2m
Project C: Outlay $1.5m, NPV $0.5m
Project D: Outlay $2.5m, NPV $0.8m
In what order should the projects be ranked to maximize NPV?
Answer options:
A.
B, D, A, C
B.
B, C, D, A
C.
A, C, D, B
D.
C, A, D, B
How to approach this question
Calculate the Profitability Index (PI) for each project. PI = NPV / Initial Outlay. Rank the projects from highest PI to lowest PI.
Full Answer
B.B, C, D, A✓ Correct
Under single-period capital rationing with divisible projects, we rank projects using the Profitability Index (PI) to maximize return per dollar of scarce capital. PI = NPV / Outlay.
Project A: 0.6 / 2.0 = 0.30
Project B: 1.2 / 3.0 = 0.40
Project C: 0.5 / 1.5 = 0.33
Project D: 0.8 / 2.5 = 0.32
Ranking from highest to lowest: B, C, D, A.
Common mistakes
Ranking by absolute NPV (which is only appropriate for indivisible projects).
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