Question

You are asked to evaluate the following two projects for Boring Corporation. Use a discount rate of 12 percent. Use Appendix B.

Project X (DVDs of the Weather Reports) ($16,000 Investment)						Project Y (Slow-Motion Replays of Commercials) ($36,000 Investment)
Year		Cash Flow				Year		Cash Flow
1			$8,000			1			$18,000
2			6,000			2			11,000
3			7,000			3			12,000
4			6,600			4			14,000

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

PI            

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

PI            

c. Using the NPV method combined with the PI approach, which project would you select? Use a discount rate of 12 percent.

• Project Y

• Project X

Answer 1

a.Project X

Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$16,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the discount rate of 12%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 12% discount rate is $5,102.90.

Profitability Index= $5,102.90 + $16,000 / $16,000

                                   = $21,102.90 / $16,000

                                   = 1.3189   1.32.

b.Project Y

Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$36,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the discount rate of 12%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 12% discount rate is $6,279.18.

Profitability Index= $6,279.18 + $36,000 / $36,000

                                   = $42,279.18 / $36,000

                                   = 1.1744   1.17.

c..Project X should be selected since it has a higher profitability index.