Question

Consider the following projects: Cash Flows ($) Project C0 C1 D –11,300 22,600 E –21,300 37,275 Assume that the projects are mutually exclusive and that the opportunity cost of capital is 9%.

a. Calculate the profitability index for each project. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Project Profitability Index

D

E

b-1. Calculate the profitability-index using the incremental cash flows. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Profitability-index

b-2. Which project should you choose?

Project D

Project E

Answer 1

a. NPV of Project D = -11300 + 22600/(1+9%) = 9433.94
PI of Project D = 1 + NPV/Investment = 1 + 9433.94/11300 = 1.83

NPV of Project D = -1= -21300 + 37275/(1+9%) = 12897.25
PI of Project D = 1 + NPV/Investment = 1 + 12897.25/21300 = 1.61

b-1) Incremental Investment of Project D = -21300 -(-11300) = -10000
Incremental Cash Flow of Project E = 37,275 - 22,600 = 14675
NPV = -10000 + 14675/(1+9%) = 3463.30
PI = 1 + NPV/Investment = 1 + 3463.30/10000 = 1.35

b-2) Project E should chosen because incremental PI is greater than 1

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