Question

Year	Cash Flow
0	−$7,700
1	5,100
2	5,100
3	4,400

  

Required :

(a)	What is the profitability index for the cashflows if the relevant discount rate is 9 percent?
	(Click to select)$1.687$1.606$1.526$1.558$1.655

   

(b)	What is the profitability index for the cashflows if the relevant discount rate is 17 percent?
	(Click to select)$1.449$1.477$1.365$1.407$1.336

   

(c)	What is the profitability index for the cashflows if the relevant discount rate is 27 percent?
	(Click to select)1.2471.2111.1511.1751.272

Answer 1

The profitability index is defined as the PV of the cash inflows divided by the PV of the cash outflows.

(a) The equation for the profitability index at a required return of 9 percent is:

PI = ($5,100 / 1.09 + $5,100 / 1.09² + $4,400 / 1.09³) / $7,700 = 1.606

(b) The equation for the profitability index at a required return of 17 percent is:

PI = ($5,100 / 1.17 + $5,100 / 1.17² + $4,400 / 1.17³) / $7,700 = 1.407

(c) The equation for the profitability index at a required return of 27 percent is:

PI = ($5,100 / 1.27 + $5,100 / 1.27² + $4,400 / 1.27³) / $7,700 = 1.211