Question

You are asked to evaluate the following two projects for the Norton corporation. Use a discount rate of 12 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) ($48,000 Investment)						Project Y (Slow-Motion Replays of Commercials) ($68,000 Investment)
Year		Cash Flow				Year		Cash Flow
1		$	24,000			1		$	34,000
2			22,000			2			27,000
3			23,000			3			28,000
4			22,600			4			30,000

  
a. Calculate the profitability index for project X. (Do not round intermediate calculations and round your answer to 2 decimal places.)

    

  
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 based on the profitability index?

• Project X

• Project Y

Answer 1

a

Project X
Discount rate	0.12
Year	0	1	2	3	4
Cash flow stream	-48000	24000	22000	23000	22600
Discounting factor	1	1.12	1.2544	1.404928	1.5735194
Discounted cash flows project	-48000	21428.57	17538.27	16370.95	14362.709
NPV = Sum of discounted cash flows
NPV Project X =	21700.49
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
PI= (NPV+initial inv.)/initial inv.
=(21700.49+48000)/48000
1.45
b
Project Y
Discount rate	0.12
Year	0	1	2	3	4
Cash flow stream	-68000	34000	27000	28000	30000
Discounting factor	1	1.12	1.2544	1.404928	1.5735194
Discounted cash flows project	-68000	30357.14	21524.23	19929.85	19065.542
NPV = Sum of discounted cash flows
NPV Project Y =	22876.77
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
PI= (NPV+initial inv.)/initial inv.
=(22876.77+68000)/68000
1.34

c

Choose Project X as it has higher PI