. Preference Decisions: NPV vs. IRR vs. Profitability Index

Stephens Industries is contemplating four projects: Project P, Project Q, Project R, and Project S. The capital costs and estimated after- tax net cash flows of each project are shown in the table that follows. Stephens’s after- tax cost of capital is 12 percent. Excess funds can-not be reinvested at greater than 12 percent.
Initial cost $ 200,000 $ 235,000 $ 190,000 $ 210,000
Annual cash flows:
Year 1 93,000 90,000 45,000 40,000
Year 2 93,000 85,000 55,000 50,000
Year 3 93,000 75,000 65,000 60,000
Year 4 0 55,000 70,000 65,000
Year 5 0 50,000 75,000 75,000
Net present value $ 23,370 $ 29,827 $ 27,233 $( 7,854)
Internal rate of 18.7% 17.6% 17.2% 10.6%
return Profitability index 1.12 1.13 1.14 0.95

Required
A. Which of the four projects are acceptable ­options? Why?

1 answer

Project R, which has a minimal initial cost but have a higher profitability index
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