# Year       Cash Flow (I)   Cash Flow (II)   0            \$51,000            \$14,400   1              24,800              7,800   2              24,800              7,800   3              24,800              7,800 The Sloan Corporation is trying to choose between the following two mutually exclusive design projects: a. If the required return is 10 percent and the company applies the profitability index decision rule, which project should the firm accept? b. If the company applies the NPV decision rule, which project should it take? c. Explain why your answers in (a) and (b) are different.

Question
248 views

Year       Cash Flow (I)   Cash Flow (II)

0            \$51,000            \$14,400

1              24,800              7,800

2              24,800              7,800

3              24,800              7,800

The Sloan Corporation is trying to choose between the following two mutually exclusive design projects: a. If the required return is 10 percent and the company applies the profitability index decision rule, which project should the firm accept? b. If the company applies the NPV decision rule, which project should it take? c. Explain why your answers in (a) and (b) are different.

check_circle

Step 1

Part (a)

Profitability Index, PI  = PV of future cash flows / Initial investment

PV of a cash flow, Ci occuring at the end of period "i" = Ci / (1 + r)i where r = required return = 10%

For Project I:

PV of future cash flows = 24,800 / (1 + 10%) + 24,800 / (1 + 10%)2 + 24,800 / (1 + 10%)3 = \$61,673.93

Initial investment = \$51,000

Hence, PII = 61,673.93 / 51,000 = 1.21

Step 2

For Project II:

PV of future cash flows = 7,800 / (1 + 10%) + 7,800 / (1 + 10%)2 + 7,800 / (1 + 10%)3 = \$19,397.45

Initial investment = \$14,400

Hence, PIII = 19,397.45 / 14,400 = 1.35

Step 3

Decision criteria using PI: Accept a project if it's PI > 1.0

Since, PI of both the projects are > 1.0, hence the firm should...

### Want to see the full answer?

See Solution

#### Want to see this answer and more?

Solutions are written by subject experts who are available 24/7. Questions are typically answered within 1 hour.*

See Solution
*Response times may vary by subject and question.
Tagged in 