Question

The Sloan Corporation is trying to choose between the following two mutually exclusive design projects:

  

Year	Cash Flow (I)				Cash Flow (II)
0	–$	61,000			–$	18,300
1		28,100				9,950
2		28,100				9,950
3		28,100				9,950

   

a-1	If the required return is 10 percent, what is the profitability index for both projects? (Do not round intermediate calculations. Round your answers to 3 decimal places, e.g., 32.161.)

  

	Profitability Index
Project I
Project II

  

a-2	If the company applies the profitability index decision rule, which project should the firm accept?
	Project I Project Il

  

b-1	What is the NPV for both projects? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

  

	NPV
Project I	$
Project II	$

  

b-2	If the company applies the NPV decision rule, which project should it take?
	Project I Project II

Answer 1

Solution :

a - 1.

If the required return is 10 percent, the profitability index for both projects is as follows :

Project I = 1.146

Project II = 1.352

a-2.

If the company applies the profitability index decision rule, the project that should be accept is Project II, which has the higher profitability index.

b - 1.

The NPV for both projects is as follows :

Project I = $ 8,880.54

Project II = $ 6,444.18

b - 2.

If the company applies the NPV decision rule, the project that should be accept is Project I, which has the higher Net Present value.

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.