Year Cash Flow Project X Cash Flow Project Z -0- -400,000 -50,000 1 25,000 20,00

Question

     Year                Cash Flow Project X                    Cash Flow Project Z
      -0-                   -400,000                                       -50,000
        1                       25,000                                        20,000
        2                       60,000                                        15,000
        3                       60,000                                        20,000
        4                     540,000                                        20,000
Whichever project you chose, if any, you require a 15% return on your investment

Using the profitability index criterion, which investment should you chose? Why

Explanation / Answer

PI of X=PV of cash inflows/Initial Cash Outlay=(25000/1.15^1+60000/1.15^2+60000/1.15^3+540000/1.15^4)/400000=1.038

PI of Y=PV of cash inflows/Initial Cash Outlay=(20000/1.15^1+15000/1.15^2+20000/1.15^3+20000/1.15^4)/50000=1.066

Since PI of Y is greater than PI of X , I will select Project-Y.

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