Question

In: Finance

Profitability index Estimating the cash flow generated by $1 invested in a project The profitability index...

Profitability index

Estimating the cash flow generated by $1 invested in a project

The profitability index (PI) is a capital budgeting tool that is defined as the present value of a project’s cash inflows divided by the absolute value of its initial cash outflow. Consider this case:

Happy Dog Soap Company is considering investing $2,225,000 in a project that is expected to generate the following net cash flows:

Year

Cash Flow

Year 1 $275,000
Year 2 $500,000
Year 3 $450,000
Year 4 $450,000

Happy Dog Soap Company uses a WACC of 10% when evaluating proposed capital budgeting projects. Based on these cash flows, determine this project’s PI (rounded to four decimal places):

0.5588

0.7058

0.5882

0.6764

Happy Dog Soap Company’s decision to accept or reject this project is independent of its decisions on other projects. Based on the project’s PI, the firm should ........... the project. (Reject or accept)

By comparison, the NPV of this project is ........... (-$916,329, -$733,063, -$1,007,962) . On the basis of this evaluation criterion, Happy Dog Soap Company should ........ (invest or not invest) in the project because the project ...... (will not or will) increase the firm’s value.

A project with a negative NPV will have a PI that is ........ (greater then 1.0, equal to 1.0 or less than 1.0) ; when it has a PI of 1.0, it will have an NPV ............. (Greater then $0, equal to $0 or less than $0)

Solutions

Expert Solution


Related Solutions

11. Profitability index Estimating the cash flow generated by $1 invested in a project The profitability...
11. Profitability index Estimating the cash flow generated by $1 invested in a project The profitability index (PI) is a capital budgeting tool that is defined as the present value of a project’s cash inflows divided by the absolute value of its initial cash outflow. Consider this case: Purple Whale Foodstuffs is considering investing $2,750,000 in a project that is expected to generate the following net cash flows: Year Cash Flow Year 1 $350,000 Year 2 $500,000 Year 3 $425,000...
9. Profitability index Estimating the cash flow generated by $1 invested in a project The profitability...
9. Profitability index Estimating the cash flow generated by $1 invested in a project The profitability index (PI) is a capital budgeting tool that is defined as the present value of a project’s cash inflows divided by the absolute value of its initial cash outflow. Consider this case: Happy Dog Soap Company is considering investing $2,750,000 in a project that is expected to generate the following net cash flows: Year Cash Flow Year 1 $275,000 Year 2 $500,000 Year 3...
Profitability index           Estimating the cash flow generated by $1 invested in investment The profitability index (...
Profitability index           Estimating the cash flow generated by $1 invested in investment The profitability index ( PI) is a capital budgeting tool that provides another way to compare a project's benefits and costs. It is computed as a ratio of the discounted value of the net cash flows expected to be generated by a project over its life (the project's expected benefits) to its net cost (NINV). A project's PI value can be interpreted to indicate a project's discounted return...
Profitability index. Given the discount rate and the future cash flow of each project listed in...
Profitability index. Given the discount rate and the future cash flow of each project listed in the following​ table, use the PI to determine which projects the company should accept.   Cash Flow Project U Project V   Year 0 -$1,800, 000 -$2, 400,000   Year 1 ​$450,000 ​$1, 200,000   Year 2 ​$450,000 ​$1,000,000   Year 3 ​$450,000 ​$800, 000   Year 4 ​$450, 000 ​$600,000   Year 5 ​$450,000 ​$400,000   Discount rate 7​% 12​%
1. Based on the profitability index rule, should a project with the following cash flows be...
1. Based on the profitability index rule, should a project with the following cash flows be accepted if the discount rate is 12 percent? Why or why not? Year Year Cash Flow 0 $-26,200 1 $11,800 2 $0 3 $24,900
Calculate the project cash flow generated for Project A and Project B using the NPV method....
Calculate the project cash flow generated for Project A and Project B using the NPV method. Which project would you select, and why? Which project would you select under the payback method? The discount rate is 10% for both projects. Use Microsoft® Excel® to prepare your answer. Note that a similar problem is in the textbook in Section 5.1. Sample Template for Project A and Project B: “Table showing investments and returns for Project A and Project B. Project A...
Calculate the project cash flow generated for Project A and Project B using the NPV method...
Calculate the project cash flow generated for Project A and Project B using the NPV method (Show your calculations): . Project A: Invest $10k today and receive $5k at the end of this year and for another 2 years (in 12 mos, in 24 mos, in 36 mos), for total cash inflows of $15k. Project B: Invest $55k today and receive $20k at the end of this year and for another 2 years (in 12 mos, in 24 mos, in...
What is the profitability index of a project that costs $8,000 and provides cash flows of...
What is the profitability index of a project that costs $8,000 and provides cash flows of $2,100 in years 1 and 2 and $4,100 in years 3 and 4? The discount rate is 10%. (Do not round intermediate calculations. Round your answer to 4 decimal places.)
Profitability Index Per the strict observance of the rules of Profitability Index, this project would be...
Profitability Index Per the strict observance of the rules of Profitability Index, this project would be accepted because it meets the definition of >1. But as your pointed out, there are other considerations to factor into this decision. Most business decisions have a basis in financial support - or reason for undertaking a project. But there are non-quantitative reasons for undertaking or not undertaking a project... Class What are some non-financial reasons for undertaking a project that has a Profitability...
Calculating Profitability Index What is the profitability index for the following set of cash flows if...
Calculating Profitability Index What is the profitability index for the following set of cash flows if the relevant discount rate is 10 percent? What if the discount rate is 15 percent? If it is 22 percent? Year Cash Flow 0 −$29,500 1 16,900 2 13,600 3 8,300
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT