Question

Project	C0					C1					C2
A	−	$	2,950			+	$	2,850			+	$	2,050
B	−		2,950			+		2,290			+		1,898

a. Calculate the profitability index for A and B assuming a 23% opportunity cost of capital. (Do not round intermediate calculations. Round your answers to 4 decimal places.)

b. According to the profitability index rule, which project(s) should you accept?

• Project A

• Project B

• Both

• Neither

Answer 1

a)

Project A:

Profitability index = Present value / initial investment

Present value = 2850 / (1 + 0.23)¹ + 2050 / (1 + 0.23)²

Present value = 3,672.0867

Profitability index = 3,672.0867 / 2950

Profitability index = 1.2448

Project B:

Profitability index = Present value / initial investment

Present value = 2290 / (1 + 0.23)¹ + 1898 / (1 + 0.23)²

Present value = 3,116.332871

Profitability index = 2,659.729448 / 2500

Profitability index = 1.0564

b)

Both

Projects having profitability index of more than 1 should always be accepted.