Question

You are asked to evaluate the following two projects for the Norton corporation. Use a discount rate of 14 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) ($20,000 Investment) Project Y (Slow-Motion Replays of Commercials) ($40,000 Investment) Year Cash Flow Year Cash Flow 1 $ 10,000 1 $ 20,000 2 8,000 2 13,000 3 9,000 3 14,000 4 8,600 4 16,000 a. Calculate the profitability index for project X. (Do not round intermediate calculations and round your answer to 2 decimal plac es.) 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? Project X Project Y

Answer 1

(a)-Profitability Index (PI) for Project X (Videotapes of the Weather Report)

Year	Annual cash inflow ($)	Present Value factor at 14.00%	Present Value of Annual cash inflow ($)
1	10,000	0.877193	8,771.93
2	8,000	0.769468	6,155.74
3	9,000	0.674972	6,074.74
4	8,600	0.592080	5,091.89
TOTAL			26,094.30

Profitability Index (PI) for Project X = Present Value of annual cash inflows / Initial Investment

= $26,094.30 / $20,000

= 1.30

(b)-Profitability Index (PI) for Project Y (Slow-Motion Replays of Commercials)

Year	Annual cash inflow ($)	Present Value factor at 14.00%	Present Value of Annual cash inflow ($)
1	20,000	0.877193	17,543.86
2	13,000	0.769468	10,003.08
3	14,000	0.674972	9,449.60
4	16,000	0.592080	9,473.28
TOTAL			46,469.82

Profitability Index (PI) for Project Y = Present Value of annual cash inflows / Initial Investment

= $46,469.82 / $40,000

= 1.16

DECISION

We should select “Project X (Videotapes of the Weather Report)“. Since it has the higher Profitability Index of 1.30.

NOTE

The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)ⁿ], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.