14.) Your Firm, Inc. (YFI) is restricted to total capital spending of no more th

Question

14.) Your Firm, Inc. (YFI) is restricted to total capital spending of no more than $300,000 for the next fiscal year. YFI is considering four capital spending projects with the annual cash flows shown below Based on this information, what is the Profitability Index (P.I.) of each viable project? Based the best investment decision method available, which project or projects should YFI undertake and why? Project A Project B Project C Project D -203000 157500 120000 97500 $305,687 -375000 210000 225000 262500 $553,711 -450000 262500 300000 337500 -147000 CF 0 CF 1 CF 2 CF 3 PV of CF 1-3 93000 105000 75000 $220,125 $713.759 NPV of CFs P.I

Explanation / Answer

Profitability index is calculated as follows=the total of pv of all future cash flows/cash outflows

Given the pv of future cash inflows and the cash outflows

If the PI is greater than 1 then the project can be accepted but PI is less than 1 then project should not be accepted

Similary NPV if NPV is greater than 0 can be accepted and if less than 0 then should not be accepted

Project A

NPV=discounted future cash inflows-cash outflows

=$305687-$203000=$102687

Since npv is positive project can be accepted

PI=$305687/$203000=1.5058

Simce PI is greater than 1 project should be accepted

Project B

Since the cost of the project is restricted to $300000 project B alone cannot be done hence it should be combined but the total capital spending restricted to $300000 and hence it cannot be processed

NPV=$553711-$300000=$253711

Since the cost of the project is restricted to $300000 it is to be considered

Since NPV of the project is positive the project should be accepted

PI=553711/300000=1.8457

Since the PI is greater than 1 the project should be accepted

Project C

NPV=$220125-$147000=$73125

Since NPV of the project is positive the project should be accpeted

PI=$220125/$147000=1.4974

Since PI is greater than 1 the project should be accpeted

Project D

Same as project B

NPV=$713759-$300000=$413759

Can be accepted

PI=$713759/$300000=2.379

If project A and project C are combined and assuming mutually inclusive then

NPV=$305687+$220125-$300000=$525812-$300000=$225812

PI=$525812/$300000=1.7527

Hence based on above if it is single project Project A to be accepted since it has higher NPV and PI over project C

If the projects are combined project A and Project C should be accepted based on assumption of mutually inclusive

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