The Robb Computer Corporation is trying to choose between the following two mutu

Question

The Robb Computer Corporation is trying to choose between the following two mutually exclusive design projects:

  

   

If the required return is 12 percent, what is the profitability index for each project? (Do not round intermediate calculations. Round your answers to 3 decimal places. (e.g., 32.161))

  

  

If the company applies the profitability index decision rule, which project should the firm accept?

  

What is the NPV for each project? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places. (e.g., 32.16))

  

  

If the company applies the NPV decision rule, which project should it take?

Year Cash Flow (I) Cash Flow (II) 0 –$ 74,000 –$ 17,000 1 21,900 9,200 2 21,900 9,200 3 21,950 9,200

Explanation / Answer

Project I Year 0 1 2 3 Cash Flow -74000 21900 21900 21950 Discount rate = 12% Discount factor =1/1.12^n 1 0.892857 0.797194 0.71178 Present Value of cash flows (cash flow * discount factor) -74000 19553.57 17458.55 15623.58 Total Present Value of Cash flows = 19553.57+17458.55+15623.58             = 52635.69 Profitability index = Present Value of Cash flows / initial investment   = 52635.69/74000   = 0.711 Net Present Value = - Initial Investment + Present Value of Annual cash flows = -74000+52635.69 = -21364.31 Project II Year 0 1 2 3 Cash Flow -17000 9200 9200 9200 Discount rate = 12% Discount factor =1/1.12^n 1 0.892857 0.797194 0.71178 Present Value of cash flows (cash flow * discount factor) -17000 8214.286 7334.184 6548.378 Total Present Value of Cash flows = 8214.286+7334.184+6548.378            = 22096.85 Profitability index = Present Value of Cash flows / initial investment   = 22096.85/17000   = 1.300 Net Present Value = - Initial Investment + Present Value of Annual cash flows = -17000+22096.85 = 5096.848 or 5096.85 Answer a -1 Profitability index Project I 0.711 Project II 1.300 Answer a-2 Based on Profitability index rule, the firm should accept one with a profitability index above 1 Project I Reject Project II Accept Answer b-1 NPV Project I -$21,364.31 Project II $5,096.85 Answer b-2 Based on NPV decision rule the firm should accept the project with a positive NPV Project I Reject Project II Accept

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