Question

Consider the following two projects: Year 4 Discount Rate Project A Year 0 Year 1 Year 2 Year 3 Y Cash Cash Cash Cash Cash Flow Flow Flow Flow Flow -100405060 N/A -73 30 30 30 30 The profitability index for project B is closest to: O Select one: A. 12.64 B. 23.34 C.0.12 D. 0.17

Answer 1

Answer: D

Present value (PV) of future cash flows should be calculated first.

PV = (CF year 1 / 1.15^1) + (CF year 2 / 1.15^2) + (CF year 3 / 1.15^3) + (CF year 4 / 1.15^4)

      = (30 / 1.15) + (30 / 1.3225) + (30 / 1.520875) + (30 / 1.749006)

      = 26.086 + 22.684 + 19.725 + 17.152

      = 85.647

Now NPV should be calculated as below:

NPV = PV – Initial investment

            = 85.647 – 73

            = 12.647

Hence,

Profitability index = PV / Initial investment

                            = 12.647 / 73

                              = 0.17