Question

You are asked to evaluate the following two projects for the Norton corporation. Use a discount rate of 14 percent. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Project X (Videotapes of the Weather Report) ($54,000 Investment)						Project Y (Slow-Motion Replays of Commercials) ($74,000 Investment)
Year		Cash Flow				Year		Cash Flow
1		$	27,000			1		$	37,000
2			25,000			2			30,000
3			25,000			3			31,000
4			23,600			4			33,000

  
a. Calculate the profitability index for project X. (Do not round intermediate calculations and round your answer to 2 decimal places.)

    

  
b. Calculate the profitability index for project Y. (Do not round intermediate calculations and round your answer to 2 decimal places.)

c. Which project would you select based on the profitability index?

• Project X

• Project Y

Answer 1

(a)-Profitability Index (PI) for PROJECT-X

Year	Annual cash inflow ($)	Present Value factor at 14%	Present Value of Annual cash inflow ($)
1	27,000	0.877193	23,684.21
2	25,000	0.769468	19,236.69
3	25,000	0.674972	16,874.29
4	23,600	0.592080	13,973.09
TOTAL			73,768.28

Profitability Index (PI) for the Project = Present Value of annual cash inflows / Initial Investment

= $73,768.28 / $54,000

= 1.37

(b)-Profitability Index (PI) for PROJECT-Y

Year	Annual cash inflow ($)	Present Value factor at 14%	Present Value of Annual cash inflow ($)
1	37,000	0.877193	32,456.14
2	30,000	0.769468	23,084.03
3	31,000	0.674972	20,924.12
4	33,000	0.592080	19,538.65
TOTAL			96,002.93

Profitability Index (PI) for the Project = Present Value of annual cash inflows / Initial Investment

= $96,002.93 / $74,000

= 1.30

(c)-DECISION

“PROJECT-X” should be selected based on the profitability index. Since it ahs the higher Profitability Index of 1.37 as compared to the Profitability Index of Project-Y.

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.