Use the following mutually exclusive investment cash ﬂows for the question(s) below: If the discount rate is 14%, using proﬁtability index which of the following is true?
A) The PI of project A is less than 1.0
B) The PI of project B is less than 1.0
C) Based on the PI, project A is preferable
D) Both projects would be rejected based on the PI criterion
E) Based on the two PI's, it is obvious the IRR for both projects is less than 14%

Question

Use the following mutually exclusive investment cash ﬂows for the question(s) below:  If the discount rate is 14%, using proﬁtability index which of the following is true?
A) The PI of project A is less than 1.0 
B) The PI of project B is less than 1.0 
C) Based on the PI, project A is preferable 
D) Both projects would be rejected based on the PI criterion 
E) Based on the two PI's, it is obvious the IRR for both projects is less than 14%

Quizplus · Accepted Answer

To calculate the profitability index (PI) for each project, we divide the present value of the cash inflows by the initial investment. The formula for PI is:
PI = (PV of cash inflows) / (Initial investment)
Using a discount rate of 14%, we can calculate the present value of the cash inflows for each project:
PV of Project A = $2,350 / (1 + 0.14) + $3,700 / (1 + 0.14)^2 = $5,030.27
PV of Project B = $5,500 / (1 + 0.14) + $1,900 / (1 + 0.14)^2 = $5,085.56
Then, we can calculate the PI for each project:
PI of Project A = $5,030.27 / $4,500 = 1.118
PI of Project B = $5,085.56 / $5,000 = 1.017
Based on the PI criterion, we should choose the project with the higher PI, which is project A. Therefore, the correct answer is C.

Use the Following Mutually Exclusive Investment Cash ﬂOws for the Question(s)