The Matterhorn Corporation is trying to choose between the following two mutuall
ID: 2756026 • Letter: T
Question
The Matterhorn Corporation is trying to choose between the following two mutually exclusive design projects: Year Cash Flow (I) Cash Flow (II) 0 –$87,000 –$55,000 1 36,900 11,700 2 47,000 34,500 3 27,000 28,500 Requirement 1: (a) If the required return is 10 percent, what is the profitability index for each project? (Do not round intermediate calculations. Round your answers to 3 decimal places (e.g., 32.161).) Profitability index Project I Project II (b) If the required return is 10 percent and the company applies the profitability index decision rule, which project should the firm accept? Requirement 2: (a) If the required return is 10 percent, what is the NPV for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).) Net present value Project I $ Project II $ (b) If the company applies the NPV decision rule, which project should it take?
Explanation / Answer
Calculation of NPV and Profitability Index for Project (I)
Year
Cash Flow
Present value @ 10%
Present Value
1
36900
0.90909
33545.42
2
47000
0.82654
38847.38
3
27000
0.75131
20285.37
Total
92678.17
NPV for project (I) = ($92678.17 – $87,000) = $5678.17
Profitability Index for Project (I) = $92678.17 / $87000 = 1.06
Calculation of NPV and Profitability Index for Project (II)
Year
Cash Flow
Present value @ 10%
Present Value
1
11700
0.90909
10636.35
2
34500
0.82654
28515.63
3
28500
0.75131
21412.33
Total
60564.31
NPV = ($60564.31 – $55,000) = $5564.31
Profitability Index for Project (II) = $60564.31 / $55000 = 1.10
Thus on the basis of Profitability index project (II) should be accepted because project (II) profitability index is higher than project (I).
But on the basis of NPV project (I) should be accepted because project (I) NPV is higher than project (II).
Year
Cash Flow
Present value @ 10%
Present Value
1
36900
0.90909
33545.42
2
47000
0.82654
38847.38
3
27000
0.75131
20285.37
Total
92678.17
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