Question

Consider the following two projects: Project Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Discount C/F C/F C/F C/F C/F C/F C/F C/F Rate Alpha - 79 20 25 30 35 40 NA NA 15% Beta - 80 25 25 25 25 25 25 25 16% Assume that projects Alpha and Beta are mutually exclusive. The correct investment decision and the best rationale for that decision is to O A invest in project Alpha, since NPV Beta < NPV Alpha O B. invest in project Beta, since NPV Beta > 0. OC. invest in project Beta, since NPV Beta > NPV Alpha > 0. OD. invest in project Beta, since IRR, >IRRA Consider the following two projects: Project Year 0 Year 1 Year 2 Year 3 Year 4 Cash Flow Cash Flow Cash Flow Cash Flow Cash Flow - 100 40 50 60 NA -73 30 30 30 Discount Rate 0.14 0.14 30 The profitability index for project A is closest to: O A. 0.21 OB. 14.06 OC. 0.14 OD. 28.12

Answer 1

Year	0	1	2	3	4	5	6	7	Discount Rate
Alpha	-79	20	25	30	35	40			15%
Beta	-80	25	25	25	25	25	25	25	16%
Present value of Cashflow from Project Alpha	-79	20/(1.15)^1 = 17.3913	25/(1.15)^2 = 18.9036	30/(1.15)^3 = 19.7255	35/(1.15)^4 = 20.0114	40/(1.15)^5 = 19.8871
NPV of Project Alpha	16.9189 = -79+17.3913+18.9036+19.7255+20.0114+19.8871
Present value of Cashflow from Project Beta	-80	25/(1.16)^1 = 21.5517	25/(1.16)^2 = 18.5791	25/(1.16)^3 = 16.0164	25/(1.16)^4 = 13.8073	25/(1.16)^5 = 11.9028	25/(1.16)^6 = 10.2611	25/(1.16)^7 = 8.8457
NPV of Project Beta	20.9641 = -80+21.5517+18.5791+16.0164+13.8073+11.9028+10.2611+8.8457
Answer : C. Invest in Project Beta NPVbeta > NPValpha > 0
Year	0	1	2	3	4	Discount Rate
A	-100	40	50	60		14%
B	-73	30	30	30	30	14%
Present value of Cashflow from Project A	-100	40/(1.14)^1 = 35.0877	50/(1.14)^2 = 38.4734	60/(1.14)^3 = 40.4983
Present value of future cashflows		114.0594 = 35.0877+38.4734+40.4983
Profitability Index = Present value of future cashflows / Initial outflow			=114.0594 / 100 - 1
			= 1.1405 - 1
Answer : C.Profitability index for project A			= 0.14