Good Example Of Ranking Investment Alternatives Essay
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In order to rank the proposed projects using the profitability index (PI), the latter should calculated by using the provided information on net investment and NPV of each project. Please find below the already ranked list of projects according to their PI.
Ranked list of projects by profitability index
Thus, such projects as Project J, Project F, Project A, Project H and Project B requiring $1,175,000 of net investments should be accepted taking into account the limit of funds available for investment in the amount of $1,200,000.
As a result of such investments, the remainder of $25,000 funds will earn the cost of capital of 14%.
As the amount of NPV is used to determine the profitability index, there is a direct positive correlation between these figures, i.e. a higher NPV generates a higher profitability index. Thus, the list of accepted projects using the NPV will remain unchanged as it is the same as the previous list of accepted, including Project J, Project F, Project A, Project H and Project B.
The list of accepted projects will change taking into consideration a new amount of funds available for investment. Thus, all available funds of $1,000,000 should be spent on investing into Project J, Project F, Project A, Project H (having the highest profitability indices) and Project G (taking into account the remainder of investment funds).
Thus, the opportunity cost (OC) of the eliminated $200,000, i.e. a difference between investment options (Investopedia, LLC, n.d.), should be determined as follows:
OC = ($35,000 + $30,000 + $22,000 + $18,000 + $21,000 + $25,000 * 14%) – ($35,000 + $30,000 + $22,000 + $18,000 + $7,000) = $129,500 – $112,000 = $17,500.
Therefore, the opportunity cost of the eliminated $200,000 is $17,500.
Investopedia, LLC. (N.d.). Opportunity cost. Retrieved from http://www.investopedia.com/terms/o/opportunitycost.asp
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