Question

You are asked to evaluate the following two projects for the Norton corporation. Use a discount rate of 11 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) ($38,000 Investment)						Project Y (Slow-Motion Replays of Commercials) ($58,000 Investment)
Year		Cash Flow				Year		Cash Flow
1		$	19,000			1		$	29,000
2			17,000			2			22,000
3			18,000			3			23,000
4			17,600			4			25,000

  
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	0.11
Year	0	1	2	3	4
Cash flow stream	-38000	19000	17000	18000	17600
Discounting factor	1	1.11	1.2321	1.367631	1.5180704
Discounted cash flows project	-38000	17117.12	13797.58	13161.44	11593.665
NPV = Sum of discounted cash flows
NPV Project X =	17669.81
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
PI= (NPV+initial inv.)/initial inv.
=(17669.81+38000)/38000
1.46
b
Project Y
Discount rate	0.11
Year	0	1	2	3	4
Cash flow stream	-58000	29000	22000	23000	25000
Discounting factor	1	1.11	1.2321	1.367631	1.5180704
Discounted cash flows project	-58000	26126.13	17855.69	16817.4	16468.274
NPV = Sum of discounted cash flows
NPV Project Y =	19267.5
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
PI= (NPV+initial inv.)/initial inv.
=(19267.5+58000)/58000
1.33

c