Suppose your firm is considering two mutually exclusive, required projects with
ID: 2654437 • Letter: S
Question
Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 11 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively.
Time: 0 1 2 3
Project A Cash Flow -33,000 23,000 43,000 14,000
Project B Cash Flow -43,000 23,000 33,000 63,000
Use the PI decision rule to evaluate these projects; which one(s) should it be accepted or rejected?
accept A, reject B
accept both A and B
reject A, accept B
accept neither A nor B
Explanation / Answer
- Present value of cash inflows of Project A = [23,000 / (1+0.11)1] + [43,000 / (1+0.11)2] + [14,000 / (1+0.11)3] = $65,857.16
- PI of Project A = 65,857.16 / 33,000 = 1.996
- Present value of cash inflows of Project B = [23,000 / (1+0.11)1] + [33,000 / (1+0.11)2] + [63,000 / (1+0.11)3] = $93,569.32
- PI of Project B = 93,569.32 / 43,000 = 2.18
Thus, reject A, accept B.
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