Hello, I need help answering this question below. value: 0.50 points Problem 7-1

Question

Hello,

I need help answering this question below.

value: 0.50 points Problem 7-10 Calculating Profitability Index Suppose the following two independent investment opportunities are available to Scott, Inc. The appropriate discount rate is 10 percent Year Project Alpha Project Beta $5,900 3,000 2,900 1,800 $7,500 1,700 5,900 4,700 2 Compute the profitability index for each of the two projects. (Do not round intermediate calculations Round your answers to 3 decimal places (e.g., 32.161).) Profitability Index Project Alpha Project Beta Which project(s) should the company accept based on the profitability index rule? Project Beta Neither project Both projects Project Alpha

Explanation / Answer

Profitability index of a project measures the present value of the project's future cash flow as compared to its initial investment. A profitability index greater than 1 indicates the project would offer more than the initial outaly. Greater the index greater is the financial attractiveness of the project.

We will analyse the profitability index of Project Alpha and Project Beta.

Present value of Cash flow = CF1/(1+r)+CF2/(1+r)2+CF3/(1+r)3

Profitability index = Sum of the present value of all Cash inflow/Initial investment
   = 6476.334/5900
   = 1.098

Project Beta

Profitability Index = 9952.667 / 7500
      = 1.327


A) Profitability Index Project Alpha = 1.098
    Profitability Index Project Beta = 1.327


B) Both the projects.
According to the Profitability index rule, if the profitability index of a project is greater than 1, then the project is profitable and one can proceed. Here, both Project Alpha and Project Beta have PI greater than 1, so we can chose both the projects.

However, if we need to choose one amongst these two, then Project Beta is more profitable than Project Alpha due to greater index ratio.

Project Alpha Year Cash Flow Calculation of PV PV of cash inflow 0 -5900 1 3000 3000/1+0.10) 2727.273 2 2900 2900/1+0.10)^2 2396.694 3 1800 1800/1+0.10)^3 1352.377 Sum 6476.334

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