Question

You are asked to evaluate the following two projects for Boring Corporation. Use a discount rate of 12 percent. Use Appendix B.

 

Project X (DVDs of the Weather Reports) ($48,000 Investment)						Project Y (Slow-Motion Replays of Commercials) ($68,000 Investment)
Year		Cash Flow				Year		Cash Flow
1			$24,000			1			$34,000
2			22,000			2			27,000
3			23,000			3			28,000
4			22,600			4			30,000

 

a. Calculate the profitability index for project X. (Round "PV Factor" to 3 decimal places. Round the final answer to 2 decimal places.)

 

PI            

 

b. Calculate the profitability index for project Y. (Round "PV Factor" to 3 decimal places. Round the final answer to 2 decimal places.)

 

PI            

 

c. Using the NPV method combined with the PI approach, which project would you select? Use a discount rate of 12 percent.

 

• Project Y

• Project X

Answer 1

Step 1 ; Calculate present value of Cash Outflows
Step 2 : Calculate Present Value of Cash Inflows
Step 3 : Calculate Profitability Index
Profitability Index = Present value of cash inflows / Present value of cash outflows

a) Calculation of Profitability index of Project X

Year	Particulars	Amount	PVF @ 12%	Present Value
	Cash Outflows
0	Investment cost	$48,000.00	1	$48,000.00
	Present Value of Cash outflows (A)			$48,000.00
	Cash Inflows
1	Cash Inflows Yr 1	$24,000.00	0.892857143	$21,428.57
2	Cash Inflows Yr 2	$22,000.00	0.797193878	$17,538.27
3	Cash Inflows Yr 3	$23,000.00	0.711780248	$16,370.95
4	Cash Inflows Yr 4	$22,600.00	0.635518078	$14,362.71
	Present Value of Cash inflows (B)			$69,700.49
	Profitability Index (B/A)			1.45

a) Calculation of Profitability index of Project Y

Year	Particulars	Amount	PVF @ 12%	Present Value
	Cash Outflows
0	Investment cost	$68,000.00	1	$68,000.00
	Present Value of Cash outflows (A)			$68,000.00
	Cash Inflows
1	Cash Inflows Yr 1	$34,000.00	0.892857143	$30,357.14
2	Cash Inflows Yr 2	$27,000.00	0.797193878	$21,524.23
3	Cash Inflows Yr 3	$28,000.00	0.711780248	$19,929.85
4	Cash Inflows Yr 4	$30,000.00	0.635518078	$19,065.54
	Present Value of Cash inflows (B)			$90,876.77
	Profitability Index (B/A)			1.34

Note :
PVF(r,t) = (1/(1+r))^n