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

First lets put the information in tabular format:

Year	Project I	Project II
0	-62000	-36800
1	28300	16800
2	28300	16800
3	28300	16800

We first need to calculate the NPV of each project and using that we can find the profitability index

Project I:

Year	CF	Discount Factor	Discounted CF
0	-62000	1/(1+0.11)^0=	1	1*-62000=	$          -62,000.00
1	28300	1/(1+0.11)^1=	0.900900901	0.900900900900901*28300=	$           25,495.50
2	28300	1/(1+0.11)^2=	0.811622433	0.811622433244055*28300=	$           22,968.91
3	28300	1/(1+0.11)^3=	0.731191381	0.73119138130095*28300=	$           20,692.72
				NPV = Sum of all Discounted CF	$              7,157.13
				Profitability Index = 1+NPV/Initial investment	1+7157.13/62000 = 1.115

Project I:

Year	CF	Discount Factor	Discounted CF
0	-36800	1/(1+0.11)^0=	1	1*-36800=	$          -36,800.00
1	16800	1/(1+0.11)^1=	0.900900901	0.900900900900901*16800=	$           15,135.14
2	16800	1/(1+0.11)^2=	0.811622433	0.811622433244055*16800=	$           13,635.26
3	16800	1/(1+0.11)^3=	0.731191381	0.73119138130095*16800=	$           12,284.02
				NPV = Sum of all Discounted CF	$             4,254.41
				Profitability Index = 1+NPV/Initial investment	1+4254.41/36800 = 1.116

a-1) PI of project I = 1.115 and that of project II = 1.116

a-2) Project II has higher PI so pick that

b-1) NPV of project I = 7,157.13 and that of project II = 4,254.41

b-2) Project I has higher NPV so pick that