Question

Your answer: Question 4 (CHAPTER 9) Here's what's known about this investment opportunity: Today: the company would need to invest $450,000 In 1 year: the company would receive a profit of $100,000 In 2 years: the company would receive a profit of $300,000 In 3 years: the company would receive a profit of $300,000 In 4 years: the company would receive a profit of $100,000 The required return is 17%. After doing all sorts of calculations and analyses, the company made the following several conclusions. Which ones are CORRECT and which ones are INCORRECT? (1) (Increase decimal places for any intermediate calculations, from the default 2 to 6 or higher. Only round your final answer to TWO decimal places: for example, 1.23.) The Profitability Index of this investment opportunity equals 1.21. (2) For an investment with the Profitability Index of 1.21, "reject" is the right decision (3) For an investment with the Profitability Index of 1.21, in absolute terms the dollar amount representing the initial cost required for the investment, is less than the discounted value of all future profits. (4) For an investment with the Profitability Index of 1.21, the Net Present Value of the investment opportunity is between 0 and 1.

Answer 1

1]

PI = (NPV + initial investment) / initial investment

NPV is calculated using NPV function in Excel

PI is 1.21

Conclusion (1) is correct

А 1 Year В Cash Flow 0 $(450,000) 1 $ 100,000 2 $ 300,000 3 $ 300,000 $ 100,000 $ 95,300 1.21 6 4 7 NPV 8 PI

1 Year 2 0 3 1 42 5 3 Cash Flow -450000 100000 300000 300000 100000 =NPV(17%,B3:36)+B2 =(B7+450000)/450000 6 4 7 NPV 8 PI

2]

Conclusion (2) is incorrect

For a project with a PI higher than 1, "accept" is the right decision

3]

Conclusion (3) is correct

PI = (NPV + initial investment) / initial investment

PI will be higher than 1 if the dollar amount of initial investment is lower than the present value of future profits

4]

Conclusion (4) is incorrect

The NPV will be much higher than 1, as the PI is 1.21