Question

Consider a potential manufacturing project with the following cash flows:

Cash Flow Year -$12,000 0 $4,500 1 $4,500 2 $4,500 3 $4,500 4

Your firm's capital is constrained and it is trying to decide whether or not to pursue this project. If the relevant interest rate is 7.7%, the profitability index of this project is closest to _________________.

	a.	0.19
	b.	0.66
	c.	0.17
	d.	0.25

Answer 1

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=4500/1.077+4500/1.077^2+4500/1.077^3+4500/1.077^4

=4500/1.077+4500/1.077^2+4500/1.077^3+4500/1.077^4

=$15004.6432

NPV=Present value of inflows-Present value of outflows

=$15004.6432-$12000

=$3004.6432

PI=NPV/Present value of outflows

=$3004.6432/$12000

=0.25(Approx).