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Present Value Index
Point 1: When funds for capital investments are limited, projects can be ranked using a present value index. A project with a negative net present value will have a present value index below 1.0. Also, it is important to note that a project with the largest net present value may, in fact, return a lower present value per dollar invested.
Let's look at an example of how to determine the present value index.
Question 1: The company has a project with a 5-year life, an initial investment of $170,000, and is expected to yield annual cash flows of $55,500. What is the present value index of the project if the required rate of return is set at 6%?
Question 2: Present value index=Total present value of net cash flowsInitial investmentCalculation StepsNote: Round total present value of net cash flows and initial investment to nearest dollar. Round present value index to two decimal places. Present value index = $? divided by $170,000 = ?
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