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A company is considering two mutually exclusive projects, the company’s required return is 8 percent and...

A company is considering two mutually exclusive projects, the company’s required return is 8 percent and they do not have any capital constraints. Based on the profitability index, what is your recommendation concerning these projects? Project A Project B Year Cash Flow Year Cash Flow 0 -$38,500 0 -$42,000 1 $20,000 1 $10,000 2 $24,000 2 $40,000

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Answer #1
Computation of profitability index
year Cash flow A Cash flow B PVIF @ 8% Present value A Present value B
1 20000 10000 0.925926 18518.52 9259.259
3 24000 40000 0.857339 20576.13 34293.55
a Present value of cash inflow 39094.65 43552.81
b Outflow 38500 42000
c=a/b Profitability index         1.02         1.04
Since profitability index of project B is higher therefore firm should select project B
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