Problem 7-10 Calculating Profitability Index Suppose the following two independe

Question

Problem 7-10 Calculating Profitability Index

Suppose the following two independent investment opportunities are available to Greene, Inc. The appropriate discount rate is 10 percent.

Compute the profitability index for each of the two projects. (Do not round intermediate calculations and round your answers to 3 decimal places, e.g., 32.161.)

Which project(s) should the company accept based on the profitability index rule?

Neither project

Both projects

Project Alpha

Project Beta  

Year Project Alpha Project Beta 0 ?$ 3,900 ?$ 5,500 1 2,000 1,200 2 1,900 3,900 3 1,300 3,700

Explanation / Answer

Statement showing Cash flows Project Alpha Project Beta Particulars Time PVf 10% Amount PV Amount PV Cash Outflows                           -                        1.00            (3,900.00)            (3,900.00)            (5,500.00)            (5,500.00) PV of Cash outflows = PVCO            (3,900.00)            (5,500.00) Cash inflows                      1.00                  0.9091              2,000.00              1,818.18              1,200.00              1,090.91 Cash inflows                      2.00                  0.8264              1,900.00              1,570.25              3,900.00              3,223.14 Cash inflows                      3.00                  0.7513              1,300.00                  976.71              3,700.00              2,779.86 PV of Cash Inflows =PVCI              4,365.14              7,093.91 PI = PVCI/PVCO                      1.12                      1.29 Both projects should be accepted as PI is greater than 1 for oth the projects

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