You are asked to evaluate the following two projects for the Norton corporation. Use a discount rate of 10 percent. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.
Project X (Videotapes of the Weather Report) ($14,000 Investment) |
Project Y (Slow-Motion Replays of Commercials) ($34,000 Investment) |
|||||||||
Year | Cash Flow | Year | Cash Flow | |||||||
1 | $ | 7,000 | 1 | $ | 17,000 | |||||
2 | 5,000 | 2 | 10,000 | |||||||
3 | 6,000 | 3 | 11,000 | |||||||
4 | 5,600 | 4 | 13,000 | |||||||
a. Calculate the profitability index for project
X. (Do not round intermediate calculations
and round your answer to 2 decimal places.)
b. Calculate the profitability index for project
Y. (Do not round intermediate calculations and round your
answer to 2 decimal places.)
c. Which project would you select based on the profitability index?
Project X
Project Y
a)
Project X:
Profitability index = Present value / initial investment
Present value = 7,000 / (1 + 0.1)1 + 5,000 / (1 + 0.1)2 + 6,000 / (1 + 0.1)3 + 5,000 / (1 + 0.1)4
Present value = $18,418.8229
Profitability index = 18,418.8229 / 14,000
Profitability index = 1.32
b)
Project Y:
Profitability index = Present value / initial investment
Present value = 17,000 / (1 + 0.1)1 + 10,000 / (1 + 0.1)2 + 11,000 / (1 + 0.1)3 + 13,000 / (1 + 0.1)4
Present value = $40,862.6460
Profitability index = 40,862.6460 / 34,000
Profitability index = 1.20
c)
Project X as it has the higher profitability index
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