Suppose your firm is considering two mutually exclusive, required projects with
ID: 2765866 • 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 12 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively.
Use the PI decision rule to evaluate these projects; which one(s) should be accepted or rejected?
accept A, reject B
accept both A and B
reject A, accept B
accept neither A nor B
Time: 0 1 2 3 Project A Cash Flow -39,000 29,000 49,000 20,000 Project B Cash Flow -49,000 29,000 39,000 69,000Explanation / Answer
Statement showing Cash flows Project A Project B Particulars Time PVf@12% Amount PV Amount PV Cash Outflows - 1.00 (39,000.00) (39,000.00) (49,000.00) (49,000.00) PV of Cash outflows = PVCO (39,000.00) (49,000.00) Cash inflows 1.00 0.8929 29,000.00 25,892.86 29,000.00 25,892.86 Cash inflows 2.00 0.7972 49,000.00 39,062.50 1,000.00 797.19 Cash inflows 3.00 0.7118 20,000.00 14,235.60 69,000.00 49,112.84 PV of Cash Inflows =PVCI 79,190.96 75,802.89 PI = PVCI/PVCO 2.03 1.55 Both the projects have PI greater than 1 But since projects are mutually exclusive therefore project with higher PI should be selected accept A, reject B
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