Question

The treasurer of Tropical Fruits, Inc., has projected the cash flows of Projects A, B, and C as follows:

Year	Project A				Project B				Project C
0	−$	215,000			−$	380,000			−$	215,000
1		138,000				232,000				152,000
2		138,000				232,000				118,000

Suppose the relevant discount rate is 9 percent per year.

a. Compute the profitability index for each of the three projects. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	Profitability index
Project A
Project B
Project C

b. Compute the NPV for each of the three projects. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	NPV
Project A	$
Project B	$
Project C	$

c. Suppose these three projects are independent. Which project(s) should the company accept based on the profitability index rule?

• Project A

• Project B

• Project C

• Project A, Project B, Project C

• Project A, Project B

• Project A, Project C

• Project B, Project C

d. Suppose these three projects are mutually exclusive. Which project(s) should the company accept based on the profitability index rule?

• Project A

• Project B

• Project C

• Project A, Project B, Project C

• Project A, Project B

• Project A, Project C

• Project B, Project C

e. Suppose the budget for these projects is $595,000. The projects are not divisible. Which project(s) should be accepted?

• Project A

• Project B

• Project C

• Project A, Project B, Project C

• Project B, Project C

• Project B, Project A

• Project A, Project C

Answer 1

a. Compute the profitability index for each of the three projects

-Project A

Year	Cashflow	PVF@9%	Cashflow*PVF
0	(215,000)	1	(215,000.00)
1	138,000	0.9174	126,605.50
2	138,000	0.8417	116,151.84

Profitability index = PV of future Cash Flows / Initial Investment

= (126605.50+116151.84)/215000

= 242757.34/215000

= 1.13

-Project B

Year	Cashflow	PVF@9%	Cashflow*PVF
0	(380,000)	1	(380,000.00)
1	232,000	0.9174	212,844.04
2	232,000	0.8417	195,269.76

Profitability index = PV of future Cash Flows / Initial Investment

= (212844.04+195269.76)/380000

= 408113.80/380000

= 1.07

-Project C

Year	Cashflow	PVF@9%	Cashflow*PVF
0	(215,000)	1	(215,000.00)
1	152,000	0.9174	139,449.54
2	118,000	0.8417	99,318.24

Profitability index = PV of future Cash Flows / Initial Investment

= (139449.54+99318.24)/215000

= 238767.78/215000

= 1.11

b. Compute the NPV for each of the three projects.

- Project A

NPV = PV of Inflows - PV of Outflows

= (126605.50+116151.84)-215000

= 242757.34-215000

= 27757.34

- Project B

NPV = PV of Inflows - PV of Outflows

= (212844.04+195269.76)-380000

= 408113.80-380000

= 28113.80

​​​​​​​- Project C

NPV = PV of Inflows - PV of Outflows

= (139449.54+99318.24)-215000

= 238767.78-215000

= 23767.78

c. Suppose these three projects are independent. Which project(s) should the company accept based on the profitability index rule?

Since the projects are independent, we can select all projects having profitability index greater than 1, provided the availability of enough fund. Here all the three projects have profitability index greater than 1. So accept Project A, Project B, Project C​​​​​​​.

d. Suppose these three projects are mutually exclusive. Which project(s) should the company accept based on the profitability index rule?

Since the projects are mutually exclusive, select the project with higher profitability index. So accept Project A.

e. Suppose the budget for these projects is $595,000. The projects are not divisible. Which project(s) should be accepted?

Select those having higher NPV. Project B, Project A