Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 5, Problem 14PS
Profitability index Look again at projects D and E in Section 5-3. Assume that the projects are mutually exclusive and that the
- a. Calculate the profitability index for each project.
- b. Show how the profitability-index rule can be used to select the superior project.
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Students have asked these similar questions
What are the internal rates of return (IRR) on the three projects? Does the IRR rule in this case give the same decision as NPV? How do you know?
If the opportunity cost of capital is 11%, what is the profitability index for each project? Please analyze if, in general, decisions based on the profitability index are consistent with decisions based on NPV.
What is the most generally accepted measure to choose between the projects? Please justify your answer.
Project
A
-5000
+1000
+1000
+3000
0
B
-1000
0
+1000
+2000
+3000
C
-5000
+1000
+1000
+3000
+5000
I will need full analysis (qualitative examples and references citations and examples of relative current investments of big companies.
Refer to two projects with the following cash flows: Year Project A Project B 0 -$110 -$110 1 45 55 2 45 55 3 45 55 4 45 If the opportunity cost of capital is 11%, what is the profitability index for each project?
Profitability
index.
Given the discount rate and the future cash flow of each project listed in the following table, use the PI to determine which projects the company should accept.
What is the PI of project B?(Round to two decimal places.)
Cash Flow
Project A
Project B
Year 0
−$1,800,000
−$2,400,000
Year 1
$500,000
$1,200,000
Year 2
$600,000
$1,100,000
Year 3
$700,000
$1,000,000
Year 4
$800,000
$900,000
Year 5
$900,000
$800,000
Discount rate
5%
17%
Chapter 5 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 5 - (IRR) Check the IRRs for project F in Section 5-3.Ch. 5 - (IRR) What is the IRR of a project with the...Ch. 5 - (XIRR) What is the IRR of a project with the...Ch. 5 - Payback a. What is the payback period on each of...Ch. 5 - IRR Write down the equation defining a projects...Ch. 5 - Prob. 3PSCh. 5 - IRR rule You have the chance to participate in a...Ch. 5 - IRR rule Consider a project with the following...Ch. 5 - IRR rule Consider projects Alpha and Beta: The...Ch. 5 - Capital rationing Suppose you have the following...
Ch. 5 - Payback Consider the following projects: a. If the...Ch. 5 - Prob. 9PSCh. 5 - IRR Calculate the IRR (or IRRs) for the following...Ch. 5 - IRR rule Consider the following two mutually...Ch. 5 - IRR rule Mr. Cyrus Clops, the president of Giant...Ch. 5 - Prob. 13PSCh. 5 - Profitability index Look again at projects D and E...Ch. 5 - Prob. 15PSCh. 5 - Prob. 16PS
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- Average rate of return The following data are accumulated by Watershed Inc. in evaluating two competing capital investment proposals: Determine the expected average rate of return for each project.arrow_forwardWallace Company is considering two projects. Their required rate of return is 10%. Which of the two projects, A or B, is better in terms of internal rate of return?arrow_forwardProject S has a cost of $10,000 and is expected to produce benefits (cash flows) of $3,000 per year for 5 years. Project L costs $25,000 and is expected to produce cash flows of $7,400 per year for 5 years. Calculate the two projects’ NPVs, IRRs, MIRRs, and PIs, assuming a cost of capital of 12%. Which project would be selected, assuming they are mutually exclusive, using each ranking method? Which should actually be selected?arrow_forward
- Define each of the following terms: Capital budgeting; payback period; discounted payback period Independent projects; mutually exclusive projects Net present value (NPV) method; internal rate of return (IRR) method; profitability index (PI) Modified internal rate of return (MIRR) method NPV profile; crossover rate Nonnormal cash flow projects; normal cash flow projects; multiple IRRs Reinvestment rate assumption Replacement chain; economic life; capital rationing; equivalent annual annuity (EAA)arrow_forwardStart with the partial model in the file Ch10 P23 Build a Model.xlsx on the textbooks Web site. Gardial Fisheries is considering two mutually exclusive investments. The projects expected net cash flows are as follows: a. If each projects cost of capital is 12%, which project should be selected? If the cost of capital is 18%, what project is the proper choice? b. Construct NPV profiles for Projects A and B. c. What is each projects IRR? d. What is the crossover rate, and what is its significance? e. What is each projects MIRR at a cost of capital of 12%? At r = 18%? (Hint: Consider Period 7 as the end of Project Bs life.) f. What is the regular payback period for these two projects? g. At a cost of capital of 12%, what is the discounted payback period for these two projects? h. What is the profitability index for each project if the cost of capital is 12%?arrow_forwardComparing Investment Criteria [L01,2,3,5,7] Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) 0 -$300,000 -$40,000 1 20,000 19,000 2 50,000 12,000 3 50,000 18,000 4 390,000 10,500 Whichever project you choose, if any, you require a 15 per cent return on your investment. a. If you apply the payback criterion, which will you choose? Why? b. If you apply the discounted payback criterion, which investment will you choose? Why? c. If you apply the NPV criterion, which investment will you choose? Why? d. If you apply the IRR criterion, which investment will you choose? Why? e. If you apply the profitability index criterion, which investment will you choose? Why? f. Based on your answers in (a) through (e), which project will you finally choose? Why? Please explain your calculations and conclusionsarrow_forward
- CAPITAL BUDGETING CRITERIA Your division is considering two projects. Its WACC is 10%, and the projects’ after-tax cash flows (in millions of dollars) would be as follows: REFER IMAGE a. Calculate the projects’ NPVs, IRRs, MIRRs, regular paybacks, and discounted paybacks.b. If the two projects are independent, which project(s) should be chosen?c. If the two projects are mutually exclusive and the WACC is 10%, which project(s) should be chosen?d. Plot NPV profiles for the two projects. Identify the projects’ IRRs on the graph.e. If the WACC was 5%, would this change your recommendation if the projects were mutually exclusive? If the WACC was 15%, would this change your recommendation? Explain your answers.f. The crossover rate is 13.5252%. Explain what this rate is and how it affects the choice between mutually exclusive projects.g. Is it possible for conflicts to exist between the NPV and the IRR when independent projects are being evaluated? Explain your answer.h. Now look at the…arrow_forwardUsing accounting rate of return to make capital investment decisions Carter Company is considering three investment opportunities with the following accounting rates of return: Use the decision rule for ARR to rank the projects from most desirable to least desirable. Carter Company’s required rate of return is 8%.arrow_forwardConsider the following two mutually exclusive projects: (a) Which project has the higher profitability index at i = 7%?(b) Which project would you choose if you can raise an unlimited amount offunds in financing either project at 7%? Use the profitability index rule.arrow_forward
- NEED ASAP!!!! Consider the following: Project A Project B Net present value (a) $ 2,000 $ 3,500 Investment required (b) $ 5,000 $ 10,000 Profitability index Formula = Investment required / Net Present Value Using the method of profitability index, Which project should be selected? CHOICES: project A project B both none of thesearrow_forwardA. Calculate the profitability index for project X. B. Calculate the profitability for project Y C. Using the NPV method combined with the PI aporoach, which project would you select? Use a discount rate of 13 percentarrow_forward
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