Question

Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are 3.5 and 4.5 years, respectively.

Time: 0 1 2 3 4 5 6

Cash flow: –$5,000 $1,200   $2,400 $1,600 $1,600   $1,400   $1,200

Use the PI decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.)

Answer 1

For PI rule we will first compute the present values of all future cash flows as shown below:

Time	Cash flow	1+r	PVIF	PV = Cash flow*PVIF
1	1,200.00	1.08	0.9259	1,111.11
2	2,400.00		0.8573	2,057.61
3	1,600.00		0.7938	1,270.13
4	1,600.00		0.7350	1,176.05
5	1,400.00		0.6806	952.82
6	1,200.00		0.6302	756.20
			Total	7,323.92

Now PI = PV of future cash flows/initial investment

= $7,323.92/$5,000

= 1.46

Thus PI for this project is 1.46 and as the PI>1 the project should be accepted.