Question
In: Finance
You are analyzing two proposed capital investments with the following cash flows: Year Project X Project...
You are analyzing two proposed capital investments with the following cash flows:
|
Year |
Project X | Project Y |
| 0 | -$20,000 | -$20,000 |
| 1 | 13,630 | 7,720 |
| 2 | 5,860 | 7,720 |
| 3 | 6,160 | 7,720 |
| 4 | 2,020 | 7,720 |
The cost of capital for both projects is 10 percent.
Calculate the profitability index (PI) for each project. (Do not round discount factors. Round intermediate calculations to 2 decimal places, e.g. 15.25 and final answer to 4 decimal places, e.g. 1.2527.)
1) What is the PI for project X?
2) What is the PI for project Y?
3) If you have unlimited funds you should invest in..?
a) neither project
b) Project Y
c) Project X
d) Both projects
4) If they are mutually exclusive you should invest in...?
a) neither project
b) Project Y
c) Project X
Solutions
Expert Solution
| Answer 1 and 2 | ||||||
|
Calculation of P.V. of cash outflows |
||||||
| Project X | Project Y | |||||
| Cash outflow | P.V.F. @10% | P.V.of cash flows | Cash outflow | P.V.F. | P.V.of cash flows | |
| Year 0 | 20000 | 1 | 20000 | 20000 | 1 | 20000 |
|
P.V. of cash outflows |
20000 | 20000 | ||||
|
Calculation of P.V. of cash inflows |
||||||
| Year 1 | 13630 | 0.9090909091 | 12390.90909 | 7720 | 0.9090909091 | 7018.181818 |
| Year 1 | 5860 | 0.826446281 | 4842.975207 | 7720 | 0.826446281 | 6380.165289 |
| Year 3 | 6160 | 0.7513148009 | 4628.099174 | 7720 | 0.7513148009 | 5800.150263 |
| Year 4 | 2020 | 0.6830134554 | 1379.68718 | 7720 | 0.6830134554 | 5272.863875 |
|
P.V. of cash inflows |
23241.67065 | 24471.36125 |
|
Profitability Index = P.V. of cash inflows / P.V. of cash inflows |
|||
|
P.I. of Project X = 23242.67065/20000= |
1.162083533 | ||
|
P.I. of project Y = 24471.36125/20000= |
1.223568062 | ||
|
So, PI of project X us 1.1621 |
|||
|
PI of project Y is 1.2236 |
|||
| Answer 3 | |||
|
To choose an project on basis of PI, PI must be equal to or greater than 1. |
|||
|
As both projects are having PI more than 1. So both Poject X and Project Y should be chosen, as unlimited funds are available |
|||
|
So, answer is (d) both projects |
|||
| Answer 4 | |||
|
If projects are mutually exclusive, projects having highest PI should be chosen. |
|||
|
Project Y PI is more than Project X 1.2236. So project Y should be chosen. |
|||
|
Answer is (b) project Y. |
P.V.F. formula = 1/(1+0.10)^n
n means year 1, 2, 3 and 4
Please thumbs up.
jeff jeffy answered 1 year agoRelated Solutions
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