Question

Consider the following two mutually exclusive projects

which ever project you choose if any, you require a return of 15% on your investment.

what is the discounted payback period for each project ?

what is the profitability index for each project?

year	cash flow (a)	cash flow (b)
0	-344000	-49000
1	51000	24600
2	71000	22600
3	71000	20100
4	44600	15200

Answer 1

Project A:

Company is not able to recover its initial investment.

Discounted Payback Period = 0

Present Value of Cash Inflows = $44,349.60 + $53,683.10 + $46,682.50 + $25,502.28
Present Value of Cash Inflows = $170,217.48

Profitability Index = Present Value of Cash Inflows / Initial Investment
Profitability Index = $170,217.48 / $344,000
Profitability Index = 0.495

Project B:

Discounted Payback Period = 2 + $10,519.98 / $13,215.75
Discounted Payback Period = 2.80 years

Present Value of Cash Inflows = $21,392.16 + $17,087.86 + $13,215.75 + $8,691.36
Present Value of Cash Inflows = $60,387.13

Profitability Index = Present Value of Cash Inflows / Initial Investment
Profitability Index = $60,387.13 / $49,000
Profitability Index = 1.232

Company should choose project B as it has higher profitability index and a discounted payback period less than that of Project A.