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	–$	60,000			–$	34,800
1		27,700				16,200
2		27,700				16,200
3		27,700				16,200

   

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.)

      

a-2.	If the company applies the profitability index decision rule, which project should the firm accept?
	0 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 I 0

Answer 1

Requirement (a)(1) - Profitability Index for each project

Profitability Index = Present Value of the annual cash inflows / Initial Investment

Profitability Index – PROJECT 1

Year	Annual Cash Flow ($)	Present Value factor at 12%	Present Value of Cash Flow ($)
1	27,700	0.89286	24,732.14
2	27,700	0.79719	22,082.27
3	27,700	0.71178	19,716.31
	TOTAL		66,530.73

Profitability Index – PROJECT I = Present Value of the annual cash inflows / Initial Investment

= $66,530.73 / $60,000

= 1.109

Profitability Index – PROJECT 1I

Year	Annual Cash Flow ($)	Present Value factor at 12%	Present Value of Cash Flow ($)
1	16,200	0.89286	14,464.29
2	16,200	0.79719	12,914.54
3	16,200	0.71178	11,530.84
	TOTAL		38,909.67

Profitability Index – PROJECT I = Present Value of the annual cash inflows / Initial Investment

= $38,909.67 / $34,800

= 1.118

Requirement (a)(2) – Acceptable Project based on Profitability Index

“PROJECT II”. The Firm should accept PROJECT II, since it has the higher Profitability Index of 1.118.

Requirement (b)(1) – Net Present Value (NPV) of each Project

Net Present Value (NPV) – PROJECT I

Net Present Value = Present Value of the annual cash inflows - Initial Investment

= $66,530.73 - $66,000

= $6,530.73

Net Present Value (NPV) – PROJECT II

Net Present Value = Present Value of the annual cash inflows - Initial Investment

= $38,909.67 - $34,800

= $4,109.67

Requirement (b)(2) – Acceptable Project based of NPV

“PROJECT I”. The Firm should accept PROJECT I, since it has the higher NPV of $6,530.73.