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24 February, 09:44

Yokam Company is considering two alternative projects. Project 1 requires an initial investment of $520,000 and has a present value of cash flows of $1,300,000. Project 2 requires an initial investment of $5 million and has a present value of cash flows of $6 million.

Compute the profitability index for each project.

Based on the profitability index which project should the company prefer?

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Answers (1)
  1. 24 February, 12:46
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    1. 2.5; 1.2

    2. Project A

    Explanation:

    Given that,

    Project 1 requires:

    Initial investment = $520,000

    Present value of cash flows = $1,300,000

    Project 2 requires:

    Initial investment = $5,000,000

    Present value of cash flows = $6,000,000

    1.

    Profitability index = Present Value of Cash inflows : Investment

    Project A = $1,300,000 : $520,000

    = 2.5

    Project B = $6,000,000 : $5,000,000

    = 1.2

    2. Project A will be preferred because it has a higher profitability index than project B.
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