Question

Consider the following cash flows: Year Cash Flow 0 −$29,500 1 16,900 2 13,600 3 8,300 a. What is the profitability index for the above set of cash flows if the relevant discount rate is 10 percent? (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.) b. What is the profitability index if the discount rate is 15 percent? (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.) c. What is the profitability index if the discount rate is 22 percent?

Answer 1

The profitability index is defined as the PV of the future cash flows divided by the initial investment.

a. PI = ($16,900/1.10 + $13,600/1.10² + $8,300/1.10³) / $29,500 = 1.113

b. PI = ($16,900/1.15 + $13,600/1.15² + $8,300/1.15³) / $29,500 = 1.032

c. PI = ($16,900/1.22 + $13,600/1.22² + $8,300/1.22³) / $29,500 = 0.934