Suppose your firm is considering two mutually exclusive, required projects with
ID: 2738029 • Letter: S
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?
A reject A, accept B
B accept neither A nor B
C accept A, reject B
D accept both A and B
Time: 0 1 2 3 Project A Cash Flow -25,000 15,000 35,000 6,000 Project B Cash Flow -35,000 15,000 25,000 55,000Explanation / Answer
All Amounts in $ Profitability Index is the Present Value of all Future Cash Inflows divided by the initial Cash Outflow at T= 0 Using this formula, The PI for Project A works out to 1.9463 The PI for Project B works out to 2.2567 Hence, based on the PI Principle, both the Projects should be accepted since they fall within the payback and discounted payback limits of 2 years and 3 years respectively.
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