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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
threeyear 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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 Fall '11
 LisaPorth

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