Question

Broxton Group, a consumer electronics conglomerate, is reviewing its annual budget in wireless technology. It is considering investments in three different technologies to develop wireless communication devices. Consider the following cash flows of the three independent projects. Assume the discount rate is 8 percent. Further, the company has only $14 million to invest in new projects this year.

Cash Flows (in $ millions)

Year L6 G5 Wi-Fi

0 ?$ 4.0 ?$ 10 ?$ 14

1 7.0 8 12

2 3.5 23 26

3 1.5 14 14

a. Calculate the profitability index for each investment.

b. Calculate the NPV for each investment.

Answer 1

Solution:

a) Profitability index = Present value of cash inflow / Investment outlay

Project L6 = $10.67 / $4 = 2.67

Project G5 = $38.24 / $10 = 3.82

Project Wi Fi = $44.52 / $14 = 3.18

b) NPV = Present value of cash inflow - Investment outlay

Project L6 = $10.67 - $4 = $6.67

Project G5 = $38.24 $10 = $28.24

Project Wi Fi = $44.52 - $14 = $30.52

working:

Project L6

Investment = $4.0

Present value of cash inflow = $7.0 x 0.92593 + $3.5 x 0.85734 + $1.5 x 0.79383

= $10.67

Project G5

Investment = $10.0

Present value of cash inflow = $8 x 0.92593 + $23 x 0.85734 + $14 x 0.79383

= $38.24

Project Wi Fi

Investment = $14

Present value of cash inflow = $12 x 0.92593 + $26 x 0.85734 + $14 x 0.79383

= $44.52