Wednesday, 9 July 2014

The Angry Bird Corporation is trying to choose between the following two mutually exclusive design projects:

The Angry Bird Corporation is trying to choose between the following two mutually exclusive design projects:

 Year Cash Flow (I) Cash Flow (II) 0 –\$ 68,000 –\$ 17,600 1 31,000 9,500 2 31,000 9,500 3 31,000 9,500

 a-1 If the required return is 12 percent, what is the profitability index for both projects? (Round your answers to 3 decimal places. (e.g., 32.161))

 Profitability Index Project I Project II

 a-2 If the company applies the profitability index decision rule, which project should the firm accept? Project Il

 b-1 What is the NPV for both projects? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

 NPV Project I \$ Project II \$

 b-2 If the company applies the NPV decision rule, which project should it take? Project I

rev: 12_03_2012

Explanation:a.
 The profitability index is the PV of the future cash flows divided by the initial investment. The cash flows for both projects are an annuity, so: PII = \$31,000(PVIFA12%,3) / \$68,000 = 1.095 PIII = \$9,500(PVIFA12%,3) / \$17,600 = 1.296 The profitability index decision rule implies that we accept project II, since PIII is greater than the PII.

b.

 The NPV of each project is: NPVI = –\$68,000 + \$31,000(PVIFA12%,3) = \$6,456.77 NPVII = –\$17,600 + \$9,500(PVIFA12%,3) = \$5,217.40 The NPV decision rule implies accepting Project I, since the NPVI is greater than the NPVII.

 Calculator Solution: Note: Intermediate answers are shown below as rounded, but the full answer was used to complete the calculation.

 Project I CFo \$0 CFo –\$68,000 C01 \$31,000 C01 \$31,000 F01 3 F01 3 I = 12% I = 12% NPV CPT NPV CPT \$64,849.44 \$6,456.77

 PI = \$64,849.44 / \$68,000 = 1.095

 Project II CFo \$0 CFo –\$17,600 C01 \$9,500 C01 \$9,500 F01 3 F01 3 I = 12% I = 12% NPV CPT NPV CPT \$22,817.40 \$5,217.40

 PI = \$22,817.40 / \$17,600 = 1.296