Question

Consider the following projects: Cash Flows ($) Project C0 C1 D –11,500 23,000 E –21,500 37,625 Assume that the projects are mutually exclusive and that the opportunity cost of capital is 10%. a. Calculate the profitability index for each project. Project Profitability Index D E b-1. Calculate the profitability-index using the incremental cash flows. (D Profitability-index b-2. Which project should you choose? Project D Project E

Answer 1

CACULATION OF PRESENT VALUE OF THE PROJECT 1 & PROFITABILITY INDEX OF PROJECT D
Period	Particulars	Cash Flow	PVF of $1 @ 10 %	Present Value
0	Outflow	$         -11,500.00	$                     1.0000	$             -11,500.00
1	Inflow	$          23,000.00	$                     0.9091	$               20,909.09
	Total			$                 9,409.09
CACULATION OF PROFITABILITY INDEX OF INVESTMENT
Profitability Index = 1 + Net present Value / Initial investment
Profitability Index =          1 +		$             9,409.09	"/" By	$               11,500.00
Profitability Index =          1 +		0.82
Profitability Index =		1.82
CACULATION OF PRESENT VALUE OF THE PROJECT 1 & PROFITABILITY INDEX OF PROJECT E
Period	Particulars	Cash Flow	PVF of $1 @ 10 %	Present Value
0	Outflow	$         -21,500.00	$                     1.0000	$             -21,500.00
1	Inflow	$          37,625.00	$                     0.9091	$               34,204.55
	Total			$               12,704.55
CACULATION OF PROFITABILITY INDEX OF INVESTMENT
Profitability Index = 1 + Net present Value / Initial investment
Profitability Index =          1 +		$          12,704.55	"/" By	$               21,500.00
Profitability Index =          1 +		0.59
Profitability Index =		1.59
		Project D	Project E
Profitability Index		1.82	1.59
On the basis of Profitability index we can select the Project D because the PI of this project is High