Question

1. A project has an initial cost of $95,800, a life of 7 years, and equal annual cash inflows. The required return is 8.7 percent. According to the profitability index decision rule, what is the minimum annual cash flow necessary to accept the project?

2. You are considering the following two mutually exclusive projects. The crossover rate between these two projects is ___ percent and Project ___ should be accepted if the required return is greater than the crossover rate.

Year	Project A			Project B
0		−$23,000			−$23,000
1		8,000			16,060
2		8,000			6,000
3		16,000			8,080

3. A project has the following cash flows :

Year	Cash Flows
0	−$12,300
1	5,470
2	7,900
3	5,280
4	−1,520

Assuming the appropriate interest rate is 9 percent, what is the MIRR for this project using the discounting approach?

Answer 1

Question 1

Minimum equal Annual Cashflows required to accept the project = $ 24,438.78 or $ 24,439 (approx)

The minimum annual cashflow necessary to accept the project is the cashflows which results in a positive NPV, i.e, where the present value of inflows and outflows (investment) are equal.

As per the Profitability index rule, if the Profitability Index is greater than 1, we can accept the project.

Profitability Index =	Present Value of future cashflows
	Intial Investment

Here, Intial Investment = $ 95,800

Life of the project = 7 years

Required rate of return = 8.7%

Also given, the annual cashflows are equal. Hence, we can use the annuity factor.

Present Value of future cashflows = Annual Cashflows * Present Value Annuity Factor (for 7 years, 8.7%)

From the table (or using a calculator), we know,

Present Value Annuity Factor (for 7 years, 8.7%) = 3.92

Since, Profitability Index is to be greater than 1,

Annual Cashflows = 95,800/3.92 = $ 24,438.78

Summary

It can be computed by a simple formula.

Minimum equal Annual Cashflows required to accept the project =	Initial Investment
	Present Value Annuity Factor (n years, r%)
=	95,800
	3.92
=	24,438.78