Question

Your firm has limited capital to invest and is therefore interested in comparing projects based on the profitability index (PI), as well as other measures. What is the PI of the project with the estimated cash flows below? The required rate of return is 15.3%. Round to 3 decimals. Year 0 cash flow = -800,000 Year 1 cash flow = -180,000 Year 2 cash flow = 470,000 Year 3 cash flow = 460,000 Year 4 cash flow = 470,000 Year 5 cash flow = 470,000

Answer 1

Time Cash Flows Present Value Factor Present Value B (1/1.153)An C A*B А n 1 -1,80,000 0.8673 -1,56,114.484 4,70,000 3,53,540.558 2 0.7522 4,60,000 3,00,102.705 0.6524 4 4,70,000 0.5658 2,65,938.141 2,30,648.865 5 4,70,000 0.4907 Present value of Cash flows 9,94,115.785

Profitability Index = Present value of cash flows / Initial Investment

Profitability Index = $994,115.785 / $800,000

Profitability Index = 1.243

Since, Profitability Index is greater than 1, Accept the Project.