The Michener Corporation Company must choose Project 2 as its more profitable. Here's why,
<h3><u>SOLUTION: -</u></h3>
Profitability Index PI = ( PV of future cash flows) / Initial investment
PV of future cash flows = Σ CFn / ( 1 + r )ⁿ, where, CFn is the cash flow for year.
Required return = r = 11%
For Project 1,
PV of future Cash Flows
= 32000 / ( 1+0.11 ) + 32000 / ( 1+0.11 )² + 32000 / ( 1 + 0.11 )³ = $78198.87
Initial Investment = $63000
⇒ PI = 78198.87 / 63000 = 1.24
For Project 2,
PV of future Cash Flows
= 9750 / ( 1 + 0.11 ) + 9750 / ( 1 + 0.11 )² + 9750 / ( 1 + 0.11 )³ = $23826.21
Initial Investment = $18100
⇒P or profitability index = 23826.21 / 18100
= 1.32
Therefore, According to profitability index rule, project with highest PI should be selected. Hence, Project 2 should be selected.
To know more about profitability index, check the given links.
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