Question

Caspian Sea Drinks is considering buying the J-Mix 2000. It will allow them to make and sell more product. The machine cost $1.88 million and create incremental cash flows of $620,642.00 each year for the next five years. The cost of capital is 10.17%. What is the profitability index for the J-Mix 2000?

With business calculator if possible, thanks

Answer 1

Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$1,880,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 10.17%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 10.17% cost of capital is $462,539.33.

Profitability Index= $462,539.33 + $1,880,000/ $1,880,000

                                   = $2,342,539.33/ $1,880,000

                                   = 1.2460  1.25.

In case of any query, kindly comment on the solution.