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	–$	74,000			–$	17,000
1		21,900				9,200
2		21,900				9,200
3		21,950				9,200

   

a-1.	If the required return is 12 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.)

  

	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 II

  

b-1.	What is the NPV for each project? (A negative answer 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 II Project I

Answer 1

Project I:

Present value=21900/(1+12%)^1+21900/(1+12%)^2+21900/(1+12%)^3
=19553.57143+17458.54592+15587.98743
=52600.10478

Project II:
Present value=9200/(1+12%)^1+9200/(1+12%)^2+9200/(1+12%)^3
=8214.285714+7334.183673+6548.37828
=22096.84767

Part a-1:
Profitability index=Present value of future cash flows/Initial investment

Profitability index for project I=52600.10478/74000=0.7108
Profitability index for project II=22096.84767/17000=1.2998

Part a-2:
If the company applies the profitability index decision rule then it should accept the project with higher profitability index.
It should accept project II with profitability index of 1.2998

Part b-1:
NPV=-Initial cash outflow + Present value of future cash flows

NPV for project I=-74000+52600.10478=-21399.895
NPV for project II=-17000+22096.84767=5096.85

Part b-2:
If the company applies the NPV decision rule, it should accept the project with higher NPV
So,it should accept project II with NPV of $5096.85