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Homework answers / question archive / Evaluate the following projects, using the profitability index
Evaluate the following projects, using the profitability index. Assume a cost of capital of 12%.
Project S
Project T
Initial Cash Outflow
-$390,000
-$750,000
Year 1 Cash flow
34,500
480,000
Year 2 Cash flow
190,500
285,000
Year 3 Cash flow
285,000
225,000
Required:
a). What is the profitability index for each project? (3 marks)
b). If the projects are independent, which would you accept according to the profitability index criterion? (1 mark)
c). If these projects are mutually exclusive, which would you accept according to the PI criterion? (1 mark)
a). Profitability index (PI) for project S = 0.99
For project T = 1.09
b). If the projects are independent the project that have PI is greater than 1 should be accepted. So, the project T should be accepted because the PI for project T is greater than the 1.
c). If the projects are mutually exclusive the project that have highest PI should be accepted. So, the project T should be accepted because the PI for project T is higher than the project S.
