Ranking Investment Proposals A Profitability Index Can Be Used to Rank Investment Proposals

question 83

Essay

Ranking investment proposals
A profitability index can be used to rank investment proposals.
i. Define the profitability index.
ii. Two projects are under consideration. Project 1 has net present value (NPV) of
$20 000, project 2 has NPV of $200 000. Which project is better? Explain. What weakness in the NPV analysis does the profitability index address? Explain.
iii. 'Capital rationing' is mentioned as one of the reasons why acceptable investment projects are 'ranked'.
(a) In this context, what is an 'acceptable capital project'?
(b) One interpretation of 'capital rationing' is that the firm has a limited amount of capital available. If this is true, what problem does this present in the use of the discounted cash flow model?
(c) What other reasons besides a lack of capital may lead to the phenomenon described as capital rationing?

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Definitions:

Idea-Generation

The process of creating, developing, and communicating new concepts or solutions.

Defying Orders

The act of refusing to obey direct instructions or commands from a superior or authority figure.

Extrinsic Rewards

Benefits provided by an external source, such as money, grades, or praise, that motivate individuals to perform tasks.

Import Information

Critical data or facts that are brought in from an external source which can influence decision-making processes.