Yokam Company is considering two alternative projects. Project 1 requires an ini

Question

Yokam Company is considering two alternative projects. Project 1 requires an initial investment of $510,000 and has a present value of cash flows of $1,250,000. Project 2 requires an initial investment of $5 million and has a present value of cash flows of $6 million. 1. Compute the profitability index for each project. Profitability Index Choose Numerator: Choose Denominator: Profitability Index Profitability index Project 1 Project 2 2. Based on the profitability index, which project should the company prefer? Project 1 Project 2

Explanation / Answer

1.

Profitability Index = Present Value of cash inflows / Present Value of cash Outflows

2. The correct answer is Project 1

Since the Project 1 has a higher Profitability Index , it is preferred.

Numerator / Denominator = Profitability Index Present Value of Cash Flows / Initial Investment = Profitability Index Project 1 12,50,000 / 5,10,000 = 2.45 Project 2 60,00,000 / 50,00,000 = 1.2

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