Suppose your firm is considering two mutually exclusive, required projects with

Question

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively.

Use the PI decision rule to evaluate these projects; which one(s) should it be accepted or rejected?

  Time: 0 1 2 3   Project A Cash Flow -35,000 25,000 45,000 16,000   Project B Cash Flow -45,000 25,000 35,000 65,000

Explanation / Answer

PI of A = (25000/1.08 + 45000/1.08^2+ 16000/1.08^3)/35000= 2.13

PI of B = (25000/1.08 + 35000/1.08^2+ 65000/1.08^3)/45000= 2.33

PI for both Aand B is greater than 1

accept both A and B

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