Question

In: Finance

The following are the cash flows of two projects: Year Project A Project B 0 ?$...

The following are the cash flows of two projects:

Year Project A Project B
0 ?$ 380 ?$ 380
1 210 280
2 210 280
3 210 280
4 210

If the opportunity cost of capital is 11%, what is the profitability index for each project? (Do not round intermediate calculations. Round your answers to 4 decimal places.)

Solutions

Expert Solution

Profitability Index (PI) for the Project-A

Year

Annual cash inflow ($)

Present Value factor at 11%

Present Value of Annual cash inflow ($)

1

210

0.900901

189.19

2

210

0.811622

170.44

3

210

0.731191

153.55

4

210

0.658731

138.33

TOTAL

651.51

Profitability Index (PI) for the Project = Present Value of annual cash inflows / Initial Investment

= $651.51 / $380

= 1.7145

Profitability Index (PI) for the Project-B

Year

Annual cash inflow ($)

Present Value factor at 11%

Present Value of Annual cash inflow ($)

1

280

0.900901

252.25

2

280

0.811622

227.25

3

280

0.731191

204.74

TOTAL

684.24

Profitability Index (PI) for the Project = Present Value of annual cash inflows / Initial Investment

= $684.24 / $380

= 1.8006

NOTE

The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)n], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.


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