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	–$	62,000			–$	36,800
1		28,300				16,800
2		28,300				16,800
3		28,300				16,800

   

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.)

      

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.)

      

b-2.	If the company applies the NPV decision rule, which project should it take?
	Project II Project I

Answer 1

a.Project I

Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$62,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the required return of 11%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 11% required return is $7,157.13.

Profitability Index= $62,000 + $7,157.13 / $62,000

= $69,157.13 / $62,000

= 1.1154 1.115.

Project II

Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$36,800. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the required return of 11%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 11% required return is $4,254.41.

Profitability Index= $36,800 + $4,254.41 / $36,800

= $41,054.41 / $36,800

= 1.1156 1.116.

a-2. According to the profitability index decision rule, the corporation should accept project II since it has the highest profitability index.

b.Project I

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$62,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the required return of 11%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 11% required return is $7,157.13.

Project II

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$36,800. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the required return of 11%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 11% required return is $4,254.41.

b-2. According to the net present value decision rule, the corporation should accept project I since it has the highest net present value.