6. You are considering the following two independent projects A an d B Year Cash
ID: 1142525 • Letter: 6
Question
6. You are considering the following two independent projects A an d B Year Cash flow Cash flow -$75,000 -$70,000 $19,000 $10,000 $48,000 $16,000 $72,000 $12,000 The required rates of return are 10% for Project A and 13% for Project B. Based upon the profitability index (PI) and the information provided in the problem, you should: A. accept both project A and project B. B. accept project A and reject project B. C. accept project B and reject project A. D. reject both project A and project B. E. disregard the PI method in this case. Justify your answer.Explanation / Answer
Acceptace rule under PI
PI > 1 accept
PI < 1 Reject
PI = 1 may accept
project A PI= PV of cash inflow of project A/ cash outflow = 19000* 1/(1+10/100)+48000*1/(1+10/100)2 +12000*1/(1+10/100)3
= 17271+39792+9021/ 75000
=66075/75000 =0.881
project B PI= PV of cash inflow of project B/ cash outflow = 10000* 1/(1+13/100)+16000*1/(1+13/100)2 +72000*1/(1+13/100)3
= 8850+9456+24696 / 70000
=430002/70000 =0.614
D. Reject both the project on the basis of PI because in both the cases PI is lesser then 1
E. option can be possibe if we have to select one project from both the given project we disregard th PI method in this case.
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