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 ?$ 220 ?$ 220 1 100 120 2 100 120 3 100 120 4 100 If the opportunity cost of capital is 10%, 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 PROJECT-A

Year

Annual cash inflow ($)

Present Value factor at 10%

Present Value of Annual cash inflow ($)

1

100

0.90909

90.91

2

100

0.82645

82.64

3

100

0.75131

75.13

4

100

0.68301

68.30

TOTAL

316.99

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

= $316.99 / $220

= 1.44

Profitability Index (PI) for PROJECT-B

Year

Annual cash inflow ($)

Present Value factor at 10%

Present Value of Annual cash inflow ($)

1

120

0.90909

109.09

2

120

0.82645

99.17

3

120

0.75131

90.16

TOTAL

298.42

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

= $298.42 / $220

= 1.36

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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