Question

Yokam Company is considering two alternative projects. Project 1 requires an initial investment of $410,000 and has a present value of cash flows of $1,300,000. Project 2 requires an initial investment of $4 million and has a present value of cash flows of $7 million.1. Compute the profitability index for each project. 2. Based on the profitability index, which project should the company prefer? O Project A O Project B

Answer 1

Answer:

Profitability index for Project 1 is 3.17

Profitability index for Project 2 is 1.75

The company should prefer project 1 based on the profitability index.

Explanation:

We calculate the profitability index by dividing the present value of future cash flows  by the initial investment. So the profitability index for project 1 will be its future cash flows divided by the initial investment.

1,300,000/410,000=3

Profitability index for Project 1 is 3.17

We will do the same to calculate the profitability index for Project 2

7,000,000/4,000,000=1.75

Profitability index for Project 2 is 1.75