1. Which of the following comes closest to the profitability index (PI) of a pro
ID: 2731946 • Letter: 1
Question
1. Which of the following comes closest to the profitability index (PI) of a project that requires an initial investment of $100 and produces a single cash flow of $160 at the end of year 10 if the required rate of return is 10%?
0.52
0.62
0.56
0.43
0.47
2. In class I offered one of two trades: (1) you give me $0.25 and I’ll give you $0.50, or (2) you give me $1.00 and I’ll give you $1.50. What was the main point of this example?
The impact of real options on the capital budgeting decision
The many shortcomings of the payback rule
The relationship between NPV and IRR
The payoff of a typical call option
The Monte Hall dilemma
a.0.52
b.0.62
c.0.56
d.0.43
e.0.47
Explanation / Answer
1. Profitability Index = Present Value of future cash flow / Initial investment required
Present Value of Cash Flow = $160 / (1.10)10 = $61.69
Profitability Index = $61.69/$100 = 0.6169
So, Option b is correct.
2. The relationship between NPV and IRR
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