Question

Gold Mining, Inc. is using the profitability index (PI) when evaluating projects. Gold Mining's cost of capital is 13.09%. What is the PI of a project if the initial costs are $2,472,241 and the project life is estimated as 6 years. The project will produce the same after-tax cash inflows of $630,586 per year at the end of the year.

Round the answer to two decimal places.

Answer 1

The PI is computed as shown below:

= Present value of future cash flows / Initial investment

Present value of future cash flows is computed as follows:

= $ 630,586 / 1.1309¹ +  $ 630,586 / 1.1309² +  $ 630,586 / 1.1309³ +  $ 630,586 / 1.1309⁴ +  $ 630,586 / 1.1309⁵ +  $ 630,586 / 1.1309⁶

= $ 2,514,493.783

So, the PI will be:

= $ 2,514,493.783 / $ 2,472,241

= 1.02 Approximately

Feel free to ask in case of any query relating to this question