Question

You are asked to evaluate the following two projects for Boring Corporation. Use a discount rate of 12 percent. Use Appendix B.

Project X (DVDs of the Weather Reports) ($36,000 Investment)						Project Y (Slow-Motion Replays of Commercials) ($56,000 Investment)
Year		Cash Flow				Year		Cash Flow
1			$18,000			1			$28,000
2			16,000			2			21,000
3			17,000			3			22,000
4			16,600			4			24,000

a. Calculate the profitability index for project X. (Round "PV Factor" to 3 decimal places. Round the final answer to 2 decimal places.)

PI            

b. Calculate the profitability index for project Y. (Round "PV Factor" to 3 decimal places. Round the final answer to 2 decimal places.)

PI            

c. Using the NPV method combined with the PI approach, which project would you select? Use a discount rate of 12 percent.

• Project Y

• Project X

Answer 1

a.

	Project X	Project Y
NPV	$ 15,487.60	$ 16,669.00

b.

	Project X	Project Y
Profitability Index (PI)	1.43	1.30

c.

Project Y

Based on NPV, Project Y is better. But, based on PI, Project X is better.

The objective of investment is to created money.So, NPV method is preferred over others to decide in case of conflict of decison.

Thus, Project Y is better.

Step-1:Calculation of present value of annual cash flow
Project X:
Year	Cash Flow	Discount factor	Present Value
a	b	c=1.12^-a	d=b*c
1	$       18,000	0.893	$ 16,074.00
2	$       16,000	0.797	$ 12,752.00
3	$       17,000	0.712	$ 12,104.00
4	$       16,600	0.636	$ 10,557.60
Total			$ 51,487.60
Project Y:
Year	Cash Flow	Discount factor	Present Value
a	b	c=1.12^-a	d=b*c
1	$       28,000	0.893	$ 25,004.00
2	$       21,000	0.797	$ 16,737.00
3	$       22,000	0.712	$ 15,664.00
4	$       24,000	0.636	$ 15,264.00
Total			$ 72,669.00
Step-2:Calculation of NPV and PI
NPV of:
Project X	=	Present Value of annual cash flow	-	Investment
	=	$ 51,487.60	-	$ 36,000.00
	=	$ 15,487.60
Project Y	=	Present Value of annual cash flow	-	Investment
	=	$ 72,669.00	-	$ 56,000.00
	=	$ 16,669.00
Profitability Index of :
Project X	=	Present Value of annual cash flow	/	Investment
	=	$ 51,487.60	/	$ 36,000.00
	=	1.43
Project Y	=	Present Value of annual cash flow	/	Investment
	=	$ 72,669.00	/	$ 56,000.00
	=	1.30