Question

Bill plans to open a self-serve grooming center in a storefront. The grooming equipment will cost $450,000. Bill expects aftertax cash inflows of $97,000 annually for seven years, after which he plans to scrap the equipment and retire to the beaches of Nevis. The first cash inflow occurs at the end of the first year. Assume the required return is 12 percent. What is the project’s profitability index (PI)?

Answer 1

A	B	C	D	E	F	G	H	I	J	K	L
2
3		Initial investment	$450,000
4
5		Cash inflow per year	$97,000
6		Period	7	Years
7
8		Required rate of return	12%
9
10		Cash flow of the project can be represented as follows:
11		Year	0	1	2	3	4	5	6	7
12		Cash Flow	($450,000)	$97,000	$97,000	$97,000	$97,000	$97,000	$97,000	$97,000
13
14		Profitability index can be calculated as follows:
15
16		Profitability index	=Present Value of future cashflows / Initial Investment
17
18		Present Value of future cash flows	=97,000*(P/A,12%,7)
19			$442,684.38	=D5*PV(D8,D6,-1,0)
20
21		Profitability index	=Present Value of future cashflows / Initial Investment
22			0.98	=D19/D3
23
24		Hence profitability index is	0.98
25