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You are analyzing a project and have gathered the following data: Year Cash Flow 0 -$175,000...

  1. You are analyzing a project and have gathered the following data:

Year

Cash Flow

0

-$175,000

1

$56,400

2

$61,800

3

$72,000

4

$75,000

  

Cost of capital is 14%. Based on the profitability index of _____ for this project, you should _____ the project, using the new method.

0.1345; accept

0.0859; accept

0.0406; accept

-0.0414; reject

-0.0785; reject
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Answer #1

PV of Future Cash Flows = =1 [CF(i) / (1 + r)i]

= [$56,400 / (1 + 0.14)] + [$61,800 / (1 + 0.14)2] + [$72,000 / (1 + 0.14)3] + [$75,000 / (1 + 0.14)4]

= $49,473.68 + $47,553.09 + $48,597.95 + $44,406.02 = $190,030.75

Profitability Index = [PV of Future Cash Flows / Initial Investment] - 1

= [$190,030.75 / $175,000] - 1 = 1.0859 - 1 = 0.0859

We should accept the project as its PI is positive.

Hence, 2nd option is correct.

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