You are asked to evaluate the following two projects for the Norton corporation.

Question

You are asked to evaluate the following two projects for the Norton corporation. Use a discount rate of 10 percent. Use Appendix B.

Calculate the profitability index for project X. (Round "PV Factor" to 3 decimal places. Round your answer to 2 decimal places.)

Calculate the profitability index for project Y. (Round "PV Factor" to 3 decimal places. Round your answer to 2 decimal places.)

Using the net present value method, combined with the profitability index approach, which project would you select?

Project X (Videotapes
of the weather report)
($10,000 investment)
Project Y (Slow-motion
replays of commercials)
($30,000 investment)
Year Cash flow Year Cash flow    1 $ 5,000 1 $ 15,000 2 3,000 2 8,000 3 4,000 3 9,000 4 3,600 4 11,000 You are asked to evaluate the following two projects for the Norton corporation. Use a discount rate of 10 percent. Use Appendix B.

Explanation / Answer

Hi,

Please find the answer as follows:

Part A:

Profitability Index = Present Value of Cash Inflows/Initial Investment

Present Value of Cash Inflows = 5000/(1+.10)^1 + 3000/(1+.10)^2 + 4000/(1+.10)^3 + 3600/(1+.10)^4 = 12488.90

Profitability Index =12488.90/10000 = 1.249

Part B:

Profitability Index = Present Value of Cash Inflows/Initial Investment

Present Value of Cash Inflows = 15000/(1+.10)^1 + 8000/(1+.10)^2 + 9000/(1+.10)^3 + 11000/(1+.10)^4 = 34522.92

Profitability Index =34522.92/30000 = 1.151

Part C:

NPV (X) = - 10000 + 12488.90 = 2488.90

NPV (Y) = -30000 + 34522.92 = 4522.92

Project Y should be selected based on PI and NPV calculations.

Thanks.

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