1 answer

5. Find out the profitability index (PI) of the following project assuming the required rate of...

Question:

5. Find out the profitability index (PI) of the following project assuming the required
rate of return is 8%. Will you accept the project? Why?
year    0 1    2 3 4    5
Cash Flow -$250,000 50,000 40,000 120,000 80,000 45,000
A. Accept the project because the PI is equal to 1.06, which is larger than 0.
B. Accept the project because the PI is equal to 0.98, which is larger than 0.
C. Reject the project because the PI is equal to 1.06, which is larger than 1.
D. Reject the project because the PI is equal to 0.98, which is lower than 1.
E. Accept the project because the PI is equal to 1.06, which is larger than 1.


Answers

Profitability Index = Present value of future cash flows / initial investment

Calculating the present value of future cash flows

Year Discount Rate (A) Amount (B) Present Value (A*B)
0 1 - 250,000 -250,000
1 0.926 50,000 46,296
2 0.857 40,000 34,294
3 0.794 120,000 95,260
4 0.735 80,000 58,802
5 0.681 45,000 30,626

Present Value of future cash flows = 265,278

Initial Investment = 250,000

Profitability Index = 265278/250000 = 1.06

E. Accept the project because the PI is equal to 1.06, which is larger than 1

.

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