Question

Problem 5-15 Profitability Index versus NPV

Hanmi Group, a consumer electronics conglomerate, is reviewing its annual budget in wireless technology. It is considering investments in three different technologies to develop wireless communication devices. Consider the following cash flows of the three independent projects available to the company. Assume the discount rate for all projects is 12 percent. Further, the company has only $25 million to invest in new projects this year.

Cash Flows (in $ millions)

Year	CDMA			G4			Wi-Fi
0	–$	6		–$	19		–$	25
1		10			17			23
2		6.5			32			37
3		3.5			25			25

   

a.	Calculate the profitability index for each investment. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

  

	Profitability index
CDMA
G4
Wi-Fi

    

b.	Calculate the NPV for each investment. (Enter your answers in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

    

	NPV
CDMA	$
G4	$
Wi-Fi	$

Answer 1

CDMA
PI= (NPV+initial inv.)/initial inv.
=(0.18+6)/6
1.03
G4
PI= (NPV+initial inv.)/initial inv.
=(-2.44+19)/19
0.87
Wi-Fi
PI= (NPV+initial inv.)/initial inv.
=(-4.7+25)/25
0.81
CDMA
Discount rate	1.21
Year	0	1	2	3
Cash flow stream	-6	10	6.5	3.5
Discounting factor	1	2.21	4.8841	10.79386
Discounted cash flows project	-6	4.524887	1.330849	0.324258
NPV = Sum of discounted cash flows
NPV CDMA =	0.18
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
G4
Discount rate	1.21
Year	0	1	2	3
Cash flow stream	-19	17	32	25
Discounting factor	1	2.21	4.8841	10.79386
Discounted cash flows project	-19	7.692308	6.551872	2.316131
NPV = Sum of discounted cash flows
NPV G4 =	-2.44
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Wi-Fi
Discount rate	1.21
Year	0	1	2	3
Cash flow stream	-25	23	37	25
Discounting factor	1	2.21	4.8841	10.79386
Discounted cash flows project	-25	10.40724	7.575602	2.316131
NPV = Sum of discounted cash flows
NPV Wi-Fi =	-4.7
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor