Anne is considering two independent projects with 2-year lives. Both projects ha

Question

Anne is considering two independent projects with 2-year lives. Both projects have been assigned a discount rate of 13 percent. She has sufficient funds to finance one or both projects. Project A costs $38,500 and has cash flows of $19,400 and $28,700 for Years 1 and 2, respectively. Project B costs $41,000, and has cash flows of $25,000 and $22,000 for Years 1 and 2, respectively. Which project, or projects, if either, should you accept based on the profitability index method and what is the correct reason for that decision? Answer options: 1. You should accept both projects since both of their PIs are positive. 2. You should accept Project A since it has the higher PI and you can only select one. 3. You should accept both projects since both of their PIs are greater than 1. 4. You should only accept project A since it has the largest PI and the PI exceeds one. 5. Neither project is acceptable.

Explanation / Answer

Project A initial cost=$ 38500 RR =13% cash flows year 1 = $ 19400 y 2= $ 28700

PV= 19400(0.885)+28700(0.783) =39641.10

PI= PV of cash flows/ initial cash outlay = 39641.10/38500=1.029

Project B

Initial cost $ 41000 RR = 13% cash inflow y1=$ 25000 y2= $ 22000

PV 25000(0.885)+22000(0.783)=39351

PI= 39351/41000=0.960

project A is acceptable

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