Question

You are choosing between two mutually exclusive projects:

Year	Cash Flow (I)	Cash Flow (II)
0	–$78,000	–$36,000
1	30,000	12,000
2	38,000	25,500
3	44,000	19,500

Requirement 1:
(a)	If the required return is 13 percent, what is the profitability index for each project? (Do not round intermediate calculations. Round your answers to 3 decimal places (e.g., 32.161).)

	Profitability index
Project I
Project II

(b)	If the required return is 13 percent and the company applies the profitability index decision rule, which project should the firm accept?
	(Click to select)Project IProject II

Requirement 2:
(a)	If the required return is 13 percent, what is the NPV for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

	Net present value
Project I	$
Project II	$

Answer 1

a.Project I

PV of future cash flows is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$78,000.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the discount rate of 13%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is $8,802.45.

Profitability Index= $8,802.45/ $78,000 = 0.11.

Project II

PV of future cash flows is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$36,000.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the required return of 13%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is $8,104.19.

Profitability Index= $8,104.19/ $36,000 = 0.23.

b.The company should accept Project II since it has the higher profitability index.

c. Project I

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$78,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the required return of 13%.
• Press the down arrow and CPT buttons to get the net present value.

Present value of cash flows at 13% required return is $8,802.45.

Project II

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$36,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the required return of 13%.
• Press the down arrow and CPT buttons to get the net present value.

Present value of cash flows at 13% required return is $8,104.19.

In case of any query, kindly comment on the solution.