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GDB Solution

 Particulars Plan A (Amount in Rs.) Plan B (Amount in Rs.) Initial investment 500,000 570,000 Cash flow year 1 120,000 132,000 Cash flow year 2 216,000 237,600 Cash flow year 3 300,000 330,000 Interest rate per annum 10%

The formula for Profitability index is : PI = [Σ CFt / (1+ i) t ]/ IO

We calculated Values according to the above formula

For Plan A:

PI  =   (120,000/1+.1) +(216,000/1+(0.1)2  ) + (300,000/1+(.1)3) /500,000

=    (109,090 +213861.4+299700.3)/500,000

PI    =     1.245 >1

For Plan B:

PI  =   (132,000/1+.1) +(237,600/1+(0.1)2  ) + (330,000/1+(.1)3) /570,000

=    (120,000 +235247.5+329,670.3)/570,000

PI    =     1.2016

Reason for Chosen project Plan: Those projects with a profitability index ratio of more than one (PI >= 1.0) are considered acceptable.

Decision Rule

Accept a project if the profitability index is greater than 1, stay indifferent if the profitability index is 1 and don't accept a project if the profitability index is below 1.

But I chose A Plan A due to following reason: If there were two or more projects that need ranking, the one with the highest profitability index would be acceptable because by calculating values plan A has greater Index than Plan B.

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