Question

Medium Size Mart, Inc. is considering a project with the following cash flows: Initial cash outlay = $2,100,000 After–tax net operating cash flows for years 1 to 3 = $775,000 per year Additional after–tax terminal cash flow at the end of year 3 = $700,000 Compute the profitability index of this project if Medium Mart’s WACC is 10%.

Answer 1

Profitability Index = Present value of Cash inflows/Initial Cash outlay

Present Value of cash inflows = 775,000*PVAF(10%, 3 years)+ 700,000*PVF(10%, 3 years)

= 775,000*2.486852 +700,000*0.751314

= $2,453230.1

Hence, Profitability Index = 2,453230.1/2,100,000

= 1.1682

i.e 1.16