ActSc 371 7.7 and 7.8 Practice Problems 1. What is the profitability index for the following cash flows, if the relevant discount rate is 15%? Year 0 $-10,000 Year 1 $6,500 Year 2 $4,000 Year 3 $2,500 A) 1 B) 1.03 C) 1.3 D) 1.05 E) 1.11 Solution: PV of cash flows after the initial investment is: 10,320.54. The PI is this value divided by the absolute value of the original investment This is 10320.54/10000=1.03 2. The Ziggy Trim and Cut Company can purchase equipment on sale for $4,300. The asset has a three-year life, will produce a cashflow of $1,200 in the first and second year, and $3,000 in the third year. The interest rate is 12%. Calculate the project's discounted payback and Profitability Index assuming end of year cash flows. Should the project be taken? Solution: CF0=-4300 CF1=1200 CF2=1200 CF3=3000 Step 1: Calculate the NPV using the calculator = -136.60 Because NPV is less than zero, discounted payback cannot be calculated. Step 2: to calculate the PI, first calculate the NPV without including the initial cashflow (i.e. -
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