Question

Cori's Sausage Corporation is trying to choose between the following two mutually exclusive design projects:

  

Year	Cash Flow (I)				Cash Flow (II)
0	–$	50,000			–$	24,800
1		24,700				13,200
2		24,700				13,200
3		24,700				13,200

   

a-1.	If the required return is 11 percent, what is the profitability index for each project? (Do not round intermediate calculations and round your answers to 3 decimal places, e.g., 32.161.)

Answer 1

a-1. profitability index = sum of present value of cash inflows/initial investment or cash outflow at Year 0

present value of cash inflows = Year 1 cash inflow/(1+required return) + Year 2 cash inflow/(1+required return)² + Year 3 cash inflow/(1+required return)³

profitability index for project I is 1.207 and 1.301 for project II.

	Project I	Project II
Year	Cash flows	PV of cash inflows	Cash flows	PV of cash inflows
0	-$50,000		-$24,800
1	$24,700	$22,252.25	$13,200	$11,891.89
2	$24,700	$20,047.07	$13,200	$10,713.42
3	$24,700	$18,060.43	$13,200	$9,651.73
Required return	11%		11%
Total		$60,359.75		$32,257.03
Profitability index		1.207		1.301

Calculations