Question

Consider the following cash flows for two mutually exclusive capital investment projects. The required rate of return is 15%. Use this

Year         Project A Cash Flow        Project B Cash Flow

0                         -$40,000                           -$30,000

1                              12,000                            9,000

2                              12,000                             9,000

3                              12,000                             9,000

4                              10,800      8,100

5                              10,800                              8,100

6                              5,400      8,100

7. What is the profitability index of project B?

a) 1.03
b) 1.06
c) .94

d) 1.09

e) 1.117

8. Calculate the net present value of project A.
a) $1,564.25
b) $1,227.71
c) $3,802
d) $2,709,21
e) $331.40

Answer 1

7.Profitability Index= PV of future cash flows/Initial investment

Project B

PV of future cash flows is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$30,000.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the required rate of return of 15%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is $2,709.21.

Profitability Index= $2,709.21/ $30000 = 0.09.

Hence, the answer is option d.

8.Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$40,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the required rate of return of 15%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 15% required rate of return is $1,277.71.

Hence, the answer is option b.

In case of any query, kindly comment on the solution