Problem 12-19 Use of profitability index [LO4] You are asked to evaluate the fol
ID: 2645946 • Letter: P
Question
Problem 12-19 Use of profitability index [LO4]
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)
($20,000 Investment)
Project Y (Slow-Motion
Replays of Commercials)
($40,000 Investment)
Year Cash Flow Year Cash Flow
1 $ 10,000 1 $ 20,000
2 8,000 2 13,000
3 9,000 3 14,000
4 8,600 4 16,000
a.
Calculate the profitability index for project X. (Do not round intermediate calculations and round your answer to 2 decimal places.)
Profitability index
b.
Calculate the profitability index for project Y. (Do not round intermediate calculations and round your answer to 2 decimal places.)
Profitability index
c.
Which project would you select?
Project X
Project Y
Explanation / Answer
Calculation of NPV:
Formula of Profitability Index:
Present Value of Cash Inflow / Outflow
Project X = 26,094.20 / 20,000 = 1.30
Project Y = 46,469.64 / 40,000 = 1.16
Project X should be selected because it has High Profitability Index.
Year DF(14%) Project X PV Project Y PV 0 -20,000 - -40,000 - 1 0.87719 10,000 8,771.90 20,000 17,543.80 2 0.76946 8,000 6,155.68 13,000 10,002.98 3 0.67497 9,000 6,074.73 14,000 9,449.58 4 0.59208 8,600 5,091.89 16,000 9,473.28 Total 26,094.20 46,469.64