Question

# Marge Simpson Inc. has following business opportunities with following cash flow information. Assume Marge’s opportunity cost...

Marge Simpson Inc. has following business opportunities with following cash flow information. Assume Marge’s opportunity cost of capital is 12%.

 Year Project A Project B 0 −\$20,000 −\$20,000 1 15,000 2,000 2 15,000 2,500 3 13,000 3,000 4 3,000 50,000
1. Calculate profitability index for both projects.
2. Calculate payback period for both projects.

profitability index = Total Present value of Cash Inflows/ otal Present value of Cash Outflows

 Year Cash Flow Project A (\$) PVIF @ 12% PV Project A ( Cash Flow * PVIF) (\$) Cash Flow Project B (\$) PV Project B ( Cash Flow * PVIF) (\$) 0 -20000 1 -20000 -20000 -20000 1 15000 .893 13395 2000 1786 2 15000 .797 11955 2500 1992.50 3 13000 .712 9256 3000 2136 4 3000 .636 1908 50000 31800

PI of A = (13395+11955+9256+1908)/20000

= 1.83

PI of B = (1786+1992.50+2136+31800) / 20000

=1.89

Payback Period

Project A

Initial Outlay = \$ 20,000

Cash flow for 3 years = \$ 7500

Balance Outlay = 20000-7500 = 12,500

cash Flow for year 4= 50000

Therefore, payback period = 3 year + 12500/50000

=3.25 years

Project B

Initial Outlay = \$ 20,000

Cash flow for 1 year = \$ 15,000

Balance Outlay = 20000-15000 = 5000

cash Flow for year 2= 15000

Therefore, payback period = 1 year + 5000/15000

=1.33 years