Question

You are analyzing a project and have prepared the following data: Year Cash Flow $169,000 $46,200 I$87,300 $41,000 I$39,000 1 12 4 Required payback period 2.5 years Required return 8.50% the project. Based on the profitability index of 0.97; accept for this project, you should 1.05; accept 1.18; accept 0.97; reject 1.05; reject

Question 15 You are analyzing a project and have prepared the following data: Year Cash Flow $169,000 $46,200 $87,300 $41,000 $39,000 Required payback period 2.5 years Required return 8.50% for this project, you should the project. Based on the profitability index of 0.97; accept 1.05; accept 1.18; accept 0.97; reject 1.05; reject

Answer 1

The Correct Answer is 1.05 ; accept

Profitability Index = (Net Present Value + Initial Investment) / Initial Investment

Calculation of Net Present Value

Net Present Value of the Project
Years	Cash flow ($)	Discounting factor @ 8.50%	Present Value($)
0	(169,000)	1	-169000.00
1	46,200	0.9217	42580.65
2	87,300	0.8495	74157.45
3	41,000	0.7829	32099.23
4	39,000	0.7216	28141.40
		Net Present Value	7978.72

Initial Investment = $169,000

Therefore Profitability Index = ($7978.72 + $169,000) / 169,000

Profitability Index = $176,978.72 / $169,000

Profitability Index = 1.05 (Rounded two decimal places)

Decision making : When Profitability Index of the project is greater than 1 then it should be accepted.

Note - How did we find the discounting factors

At year 0 the discounting factor will always be 1

Year 1 = 1/1.085

= 0.9217

Year 2 = 0.9217 / 1.085

= 0.8495

Year 3 = 0.8495 / 1.085

= 0.7829

Year 4 = 0.7829 / 1.085

= 0.7216