Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 8 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and three years, respectively.
$$\begin{array}{l}
\begin{array} {| l | l | l | l | l | }
\hline\text {Time: }&0&1&2&3\
\hline\text {Project A Cash flow:}&-20,000&10,000&30,000&1,000\
\hline\text {Project b Cash flow:}&-30,000&10,000&20,000&50,000\\hline
\end{array}
\end{array}$$
Use the PI decision rule to evaluate these projects; which one(s) should be accepted or rejected?
A) Accept both A and B
B) Accept neither A nor B
C) Accept A, reject B
D) Reject A, accept B

Question

Quizplus · Accepted Answer

The Profitability Index (PI) is calculated as the present value of future cash flows divided by the initial investment. For Project A, PI is less than 1, while for Project B, PI is greater than 1. Therefore, Project B should be accepted, and Project A should be rejected.

Suppose Your Firm Is Considering Two Mutually Exclusive, Required Projects