The treasurer of Amaro Canned Fruits, Inc., has projected the cash flows of proj
ID: 2743167 • Letter: T
Question
The treasurer of Amaro Canned Fruits, Inc., has projected the cash flows of projects A, B, and C as follows:
Year
Project A
Project B
Project C
0
-$200,000
-$350,000
-$200,000
1
125,000
215,000
130,000
2
125,000
215,000
115,000
Suppose the relevant discount rate is 12 percent a year.
a. Compute the profitability index for each of the three projects.
b. Compute the NPV for each of the three projects.
c. Suppose these three projects are independent. Which project(s) should Amaro accept based on the profitability index rule?
d. Suppose these three projects are mutually exclusive. Which project(s) should Amaro accept based on the profitability index rule?
e. Suppose Amaro's budget for these projects is $550,000. The projects are not divisible. Which project(s) should Amaro accept?
Year
Project A
Project B
Project C
0
-$200,000
-$350,000
-$200,000
1
125,000
215,000
130,000
2
125,000
215,000
115,000
Explanation / Answer
Project A
NPV = Present Value of Cash inflows - Present Value of Cash outflow
Present Value of Cash inflows = 125000 * Cumulative Present Value factors for two years @ 12 %
= 125000 * 1.690
= $ 211250
NPV of Project A = 211250 - 200000 = $ 11250
Profitability Index of Project A = Present Value of Cash inflows / Present Value of Cash outflow
= 211250 / 200000
= 1.06 (approx)
Project B
NPV = Present Value of Cash inflows - Present Value of Cash outflow
Present Value of Cash inflows = 215000 * Cumulative Present Value factors for two years @ 12 %
= 215000 * 1.690
= $ 363350
NPV of Project B = 363350 - 350000 = $ 13350
Profitability Index of Project B = Present Value of Cash inflows / Present Value of Cash outflow
= 363350 / 350000
= 1.04 (approx)
Project C
NPV = Present Value of Cash inflows - Present Value of Cash outflow
Present Value of Cash inflows = 130000 * Present Value factor for first year @ 12 % + 115000 * Present Value factor for Second year @ 12 %
= 130000 * 0.893 + 115000 * 0.797
= $ 207745
NPV of Project C = 207745 - 200000 = $ 7745
Profitability Index of Project C = Present Value of Cash inflows / Present Value of Cash outflow
= 207745 / 200000
= 1.04 (approx)
Question a) and Question b) Profitability Index & NPV of Projects
Question c) If the three projects are independent then all the projects i.e., Project A, B and C will be accepted based on profitability index rule because all the Projects having profitability index equal to or greater than 1.
Question d) If the three projects are mutually exclusive then as per profitability index rule that project will be accepted which is having highest Profitability index. Accordingly, Project A will accepted as it is having highest Profitability index of 1.06
Project A Project B Project C Profitability Index 1.06 1.04 1.04 NPV $ 11250 $ 13350 $ 7745Related Questions
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