Question

You are asked to evaluate the following two projects for Boring Corporation. Use a discount rate of 15 percent. Use Appendix B.

Project X (DVDs of the Weather Reports)

($46,000 Investment)

Year	Cash Flow
1	23,000
2	21,000
3	22,000
4	21,000

Project Y (Slow-Motion Replays of Commercials)

($66,000 Investment)

Year	Cash Flow
1	33,000
2	26,000
3	27,000
4	29,000

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 15 percent. Project Y Project X

Answer 1

Answer a.

Profitability Index = Present Value of Cash Inflows / Initial Investment
Profitability Index = $62,374 / $46,000
Profitability Index = 1.36

Answer b.

Profitability Index = Present Value of Cash Inflows / Initial Investment
Profitability Index = $82,720 / $66,000
Profitability Index = 1.25

Answer c.

Project X:

Net Present Value = Present Value of Cash Inflows - Initial Investment
Net Present Value = $62,374 - $46,000
Net Present Value = $16,374

Project Y:

Net Present Value = Present Value of Cash Inflows - Initial Investment
Net Present Value = $82,720 - $66,000
Net Present Value = $16,720

NPV of Project Y is higher but PI of Project X is higher; therefore, the company should accept Project X as it is providing higher return for each dollar of investment.