Question

You are asked to evaluate the following two projects for Boring Corporation. Use a discount rate of 10 percent. Use Appendix B.

 

Project X (DVDs of the Weather Reports) ($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. (Round "PV Factor" to 3 decimal places. Round the final answer to 2 decimal places.)

 

PI            Not attempted

 

b. Calculate the profitability index for project Y. (Round "PV Factor" to 3 decimal places. Round the final answer to 2 decimal places.)

 

PI            1.20 1.20 Correct

 

c. Using the NPV method combined with the PI approach, which project would you select? Use a discount rate of 10 percent.

 

• Project Y

Answer 1

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