Consider the following projects: Cash Flows, $ Project C0 C1 D –11,300 +22,600 E

Question

Consider the following projects: Cash Flows, $ Project C0 C1 D –11,300 +22,600 E –21,300 +37,275 Assume that the projects are mutually exclusive and that the opportunity cost of capital is 9%. a. Calculate the profitability index for each project. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Calculate the profitability-index using the incremental cash flows? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Calculate the profitability-index using the incremental cash flows? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explanation / Answer

D:

NPV=-11300+22600/1.09=9433.945

Profitability Index=1+NPV/Initial Investment=1+9433.945/11300=1.83

E:

NPV=-21300+37275/1.09=12897.25

Profitability Index=1+NPV/Initial Investment=1+12897.25/21300=1.61

Incremental Cash flows (E-D):

Year 0: (-21300-(-11300))=-10000

Year 1: +(37275-22600)=14675

NPV=-10000+14675/1.09=3463.30

So, Profitability Index =1+3463.30/10000=1.35

As the increment (E-D) is having PI greater than 1, the increment must be chosen and so the larger project E must be accepted..hence, choose Project E

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