The Angry Bird Corporation is trying to choose between the following two mutuall

Question

The Angry Bird Corporation is trying to choose between the following two mutually exclusive design projects:

If the required return is 12 percent, what is the profitability index for both projects? (Round your answers to 3 decimal places. (e.g., 32.161))

If the company applies the profitability index decision rule, which project should the firm accept?

What is the NPV for both projects? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

If the company applies the NPV decision rule, which project should it take?

The Angry Bird Corporation is trying to choose between the following two mutually exclusive design projects:

Explanation / Answer

Part a-1)

The profitability index can be calculated with the use of following formula:

Profitability Index = Present Value of Cash Inflows/Initial Investment

Present Value of Cash Inflows can be calculated with the use of following formula:

Present Value of Cash Inflows = Cash Flow Year 1/(1+Required Return)^1 + Cash Flow Year 2/(1+Required Return)^2 + Cash Flow Year 3/(1+Required Return)^3

___________

Project I

Present Value of Cash Inflows = 30,000/(1+12%)^1 + 30,000/(1+12%)^2 + 30,000/(1+12%)^3 = $72,054.94

Profitability Index = 72,054.94/65,000 = 1.109

__________

Project II

Present Value of Cash Inflows = 9,650/(1+12%)^1 + 9,650/(1+12%)^2 + 9,650/(1+12%)^3 = 23,177.67

Profitability Index = 23,177.67/17,900 = 1.295

__________

Part a-2)

Project II should be selected as it has a higher profitability index.

__________

Part b-1)

NPV is the difference between the present value of cash inflows and cash outflows. The formula for calculating NPV is:

NPV = Present Value of Cash Inflows - Present Value of Cash Outflows (here, it is initial investment)

___________

Project I

Present Value of Cash Inflows = 30,000/(1+12%)^1 + 30,000/(1+12%)^2 + 30,000/(1+12%)^3 = $72,054.94

NPV = 72,054.94 - 65,000 = $7,054.94

__________

Project II

Present Value of Cash Inflows = 9,650/(1+12%)^1 + 9,650/(1+12%)^2 + 9,650/(1+12%)^3 = 23,177.67

NPV = 23,177.67 - 17,900 = $5,277.67

__________

Part b-2)

Project I should be selected as it has a higher NPV.

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