You are analyzing two proposed capital investments with the following cash flows

Question

You are analyzing two proposed capital investments with the following cash flows: Year Project X Project Y 0 - $20,000 -$20,000 1 12,730 6,670 2 5,660 6,670 3 6,260 6,670 4 1,820 6,670 The cost of capital for both projects is 10 percent. a. Calculate the profitability index (PI) for each project. The PI for project X is______ and the PI for project Y is _____________. b. Which project, or projects, should be accepted if you have unlimited funds to invest? c. Which project should be accepted if they are mutually exclusive?

Explanation / Answer

Profitability Index => PV of Cash Inflow / PV of Cash Outflow

Projet X => 22191 / 20000 => 1.11

Project Y =>21137 /20000 => 1.06

Answer b

Project X and Project Y both should be accepted as Profitability Index in both is higher than 1.

Answer c

Project X should be accepted as its PI is greater than PI of Project Y.

Year Project X Project Y Discounting factor @10% Present Value of Project X Present Value nof Project Y 0 -20000 -20000 1 -20000 -20000 1 12730 6670 0.909 11572 6063 2 5660 6670 0.826 4675 5509 3 6260 6670 0.751 4701 5009 4 1820 6670 0.683 1243 4556 PV of Cash INflow 22191 21137 NPV $2191 $1137

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