Question

Project ABC has an initial cost of $1,000 and generates cash inflow of $2,000 at the end of year 1. Project QRS has an initial cost of $10,000 and has annual cash inflows of $4,400, $4,840, and $5,324 in year 1-3. Assuming a 10% discount rate, calculate the net present value and profitability index for both projects. Which project is better in terms of NPV? (2 points) Which project is better in terms of PI?

Answer 1

Project ABC

NPV = PV of Inflows - PV of Outflows

= 2000/1.1 - 1000

= 1818.18-1000

= 818.18

Profitability index = PV of future Cash Flows / Initial Investment

= 1818.18/1000

= 1.8182

Project QRS

Year	Cashflow	PVF@10%	Cashflow*PVF
0	(10,000)	1	(10,000.00)
1	4,400	0.9091	4,000.00
2	4,840	0.8264	4,000.00
3	5,324	0.7513	4,000.00

NPV = PV of Inflows - PV of Outflows

= (4000+4000+4000)-10000

= 12000-10000

= 2000

Profitability index = PV of future Cash Flows / Initial Investment

= 12000/10000

= 1.20

Project QRS is better as it has Higher NPV.

Project ABC is better as it has Higher Profitability index.

Both projects are acceptable as NPV is positive and PI>1