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 11 percent. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Project X (Videotapes of the Weather Report) ($22,000 Investment) Project Y (Slow-Motion Replays of Commercials) ($42,000 Investment)

Year Cash Flow Year Cash Flow

(1) $ 11,000 (1) $ 21,000

(2) $ 9,000 (2) $) 14,000

(3) $ 10,000 (3) $15,000

(4) $ 9,600 (4) $17,000

a. Calculate the profitability index for project X. (Do not round intermediate calculations and round your answer to 2 decimal places.) Profitability index

b. Calculate the profitability index for project Y. (Do not round intermediate calculations and round your answer to 2 decimal places.) Profitability index

c. Which project would you select? Project X Project Y

Explanation / Answer

a. Project X :

Present value of cash inflows at 11% discount rate = 11,000 x 0.9009 + 9,000 x 0.8116 + 10,000 x 0.7312 + 9,600 x 0.6587 = 18,918.9 + 11,362.4 + 10,968 + 11,197.9 = $ 30,849

Profitability index = Present value of cash inflows / Initial investment = 30,849 / 22,000 = 1.40

b. Project Y:

Present value of cash inflows at 11% discount rate = 21,000 x 0.9009 + 14,000 x 0.8116 + 15,000 x 0.7312 + 17,000 x 0.6587 = 9,909.9 + 7,304.4 + 7,312 + 6,323.52 = $ 52,447.2

Profitability index = 52,447.20 / 42,000 = 1.25

c. Project X should be selected as its profitability index is not only higher, but also > 1.

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