Ask Question
12 May, 22:12

Project Q has an initial cost of $211,415 and projected cash flows of $121,300 in Year 1 and $176,300 in Year 2. Project R has an initial cost of $415,000 and projected cash flows of $187,500 in Year 1 and $236,600 in Year 2. The discount rate is 8.5 percent and the projects are independent. Which project (s), if either, should be accepted based on its profitability index value?

+3
Answers (1)
  1. 12 May, 22:30
    0
    Project Q should be accepted.

    Explanation:

    In this question, we have to use the profitability index formula which is shown below:

    Profitability index = Present value of all years cash flows : Initial investment

    where,

    Present value of cash inflows is calculated by applying the discount rate which is presented below:

    For this, we have to first compute the present value factor which is computed by a formula

    = 1 : (1 + rate) ∧ number of year

    number of year = 0

    number of year = 1

    Number of year = 2

    So,

    For year 1 = 0.9216 (1 : 1.085) ∧ 1

    For year 2 = 0.8495 (1 : 1.085) ∧ 2

    Now, multiply this present value factor with yearly cash inflows

    So

    For Project Q,

    The present value of year 1 = $121,300 * 0.9216 = $111,797.235

    The present value of year 2 = $176,300 * 0.8495 = $149,758.967

    and the sum of all year cash inflow is 261,556.202

    So, the Profitability index would be equal to

    = $261,556.202 : $211,415

    = 1.23

    For Project R,

    The present value of year 1 = $187,500 * 0.9216 = $172,811.059

    The present value of year 2 = $236,600 * 0.8495 = $200,981.121

    and the sum of all year cash inflow is $373,792.180

    So, the Profitability index would be equal to

    = $373,792.180 : $415,000

    = 0.90

    Since, the Project Q has high profitability index than Project R, so Project Q should be accepted.
Know the Answer?
Not Sure About the Answer?
Find an answer to your question 👍 “Project Q has an initial cost of $211,415 and projected cash flows of $121,300 in Year 1 and $176,300 in Year 2. Project R has an initial ...” in 📗 Business if the answers seem to be not correct or there’s no answer. Try a smart search to find answers to similar questions.
Search for Other Answers