Suppose the following two independent investment opportunities are available to Fitz, Inc. The appropriate discount rate is 12%. Year Project Gamma Project Theta 0 -$2,500 -$4,100 1 1,300 800 2 1,100 2,100 3 900 3,600 Calculate the profitability index (PI) for each project. Which project should the company accept based on the PI rule? Consider the following cash flows on two mutually exclusive projects for a company. Both projects require an annual return of 15%. Year Project A Project B 0 -$725,500 -$1,450,900 1 275,000 889,000 2 413,800 647,330 3 382,075 554,280 As a financial analyst for the company, you are asked the following questions: If your decision rule is to accept the project with the higher IRR, which project should you choose? Because you are fully aware of the scale problem associated with IRR rule, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you choose? To be prudent, you compute the NPV of both projects. Which project should you choose? Is it consistent with the incremental IRR rule?
Suppose the following two independent investment opportunities are available to Fitz, Inc. The appropriate discount rate is 12%. Year Project Gamma Project Theta 0 -$2,500 -$4,100 1 1,300 800 2 1,100 2,100 3 900 3,600 Calculate the profitability index (PI) for each project. Which project should the company accept based on the PI rule? Consider the following cash flows on two mutually exclusive projects for a company. Both projects require an annual return of 15%. Year Project A Project B 0 -$725,500 -$1,450,900 1 275,000 889,000 2 413,800 647,330 3 382,075 554,280 As a financial analyst for the company, you are asked the following questions: If your decision rule is to accept the project with the higher IRR, which project should you choose? Because you are fully aware of the scale problem associated with IRR rule, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you choose? To be prudent, you compute the NPV of both projects. Which project should you choose? Is it consistent with the incremental IRR rule?
Chapter10: Capital Budgeting: Decision Criteria And Real Option
Section: Chapter Questions
Problem 15P
Related questions
Question
- Suppose the following two independent investment opportunities are available to Fitz, Inc. The appropriate discount rate is 12%.
|
Year |
Project Gamma |
Project Theta |
|
0 |
-$2,500 |
-$4,100 |
|
1 |
1,300 |
800 |
|
2 |
1,100 |
2,100 |
|
3 |
900 |
3,600 |
- Calculate the profitability index (PI) for each project.
- Which project should the company accept based on the PI rule?
- Consider the following cash flows on two mutually exclusive projects for a company. Both projects require an annual return of 15%.
|
Year |
Project A |
Project B |
|
0 |
-$725,500 |
-$1,450,900 |
|
1 |
275,000 |
889,000 |
|
2 |
413,800 |
647,330 |
|
3 |
382,075 |
554,280 |
As a financial analyst for the company, you are asked the following questions:
- If your decision rule is to accept the project with the higher IRR, which project should you choose?
- Because you are fully aware of the scale problem associated with IRR rule, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you choose?
- To be prudent, you compute the NPV of both projects. Which project should you choose? Is it consistent with the incremental IRR rule?
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