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