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	–$	59,000			–$	33,800
1		27,400				15,900
2		27,400				15,900
3		27,400				15,900

   

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

Answer:-

Part a-1): Profitability index of Project I: 1.135

Profitability index of Project II: 1.150

Part a-2): If the company applies the profitability index decision rule, firm would accept Project II as it has higher profitability Index than Project I.

Part b-1): NPV for Project I: 7957.78

NPV for Project II: 5055.06

Part b-2): If the company applies the NPV decision rule, firm would accept Project I as it has higher NPV than Project II.

Explanation:-

Profitability Index = Present Value of Cash Flows / Initial Investment

Following is the excel sheet showing the calculation of NPV and profitability Index:-

Following is the Formula Sheet of above excel sheet for easy understanding of the formulas used:-