Question

Consider the following projects: с C2 Project A B Co -$2,350 - 2,350 +$2,250 + 1,690 +$1,450 + 1,778 a. Calculate the profitability index for A and B assuming a 22% opportunity cost of capital. (Do not round intermediate calculations. Round your answers to 4 decimal places.) Project Profitability index А B b. According to the profitability index rule, which project(s) should you accept? O Project A O Project B Both O Neither

Answer 1

Part a:
Present value of future cash flows A =2250/(1+22%)^1+1450/(1+22%)^2
=1844.262295+974.2004837
=2818.462779

Present value of future cash flows B =1690/(1+22%)^1+1778/(1+22%)^2
=1385.245902+1194.571352
=2579.817254

Profitability index=(Present value of future cash flows)/(Initial investment)
Profitability index for A =(2818.462779)/(2350)=1.19934586 or 1.1993 (Rounded to two decimal places)
Profitability index for B =(2579.817254)/(2350)=1.097794576 or 1.0978 (Rounded to two decimal places)

Part b:
Answer: Both
Projects with profitability index greater than 1 should be accepted, as the profitability index of both the projects are greater than 1, both projects can be accepted.