Question

Free Spirit Industries Inc. is considering investing $500,000 in a project that is expected to generate the following net cash flows: Free Spirituses a WACC of 9% when evaluating proposed capital budgeting projects. Based on these cash flows, determine this project's PI (rounded to four decimal places): Year Cash Flow Year 1 $325,000 Year 2 $425,000 Year 3 $400,000 Year 4 $450,000 O 2.1820 O 2.6955 O 2.5671 O 2.3104 Free Spirit's decision to accept or reject this project is independent of its decisions on other projects. Based on the project's PI, the firm should the project. By comparison, the net present value (NPV) of this project is criterion, Free Spirit should On the basis of this evaluation in the project because the project increase the firm's value. When a project has a PI greater than 1.00, it will exhibit an NPV have an NPV equal to $0. Projects with PIs when it has a PI of 1.00, it will 1.00 wil exhibit negative NPVs.

Answer 1

Please see the table below for NPV calculation. The linkage column explains how each row has been calculated.

Year, N		0	1	2	3	4
Cash flows	Ci	(500,000)	325,000	425,000	400,000	450,000
Discount rate	WACC	9%
PV factor	(1 + WACC)(-N)	1.0000	0.9174	0.8417	0.7722	0.7084
PV of Cash flows	C x PV factor	(500,000)	298,165	357,714	308,873	318,791
NPV	Sum of all PV	783,544

Project's PI = (NPV + Initial investment) / Initial investment = (783,544 + 500,000) / 500,000 = 2.5671

Hence third option is correct.

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Since PI is greater than 1, the project should be acceptable.

Based on the project's PI, the firm should accept the project.

By comparison, the NPV of the project is positive. Free Spirit should invest in the project because the project will increase the firm's value.

When a project has a PI > 1.00, it will exhibit an NPV positive.

When a project has PI of 1.00, it will have zero NPV

Projects with PI less than 1.00, will exhibit negative NPV.