Question

A project has an initial cost of $95,200, a life of 9 years, and equal annual cash inflows. The required return is 8.5 percent. According to the profitability index decision rule, what is the minimum annual cash flow necessary to accept the project?

Answer 1

We know that minimum acceptable profitability index(PI) is 1; PI is present value of cash inflows/initial investment or

Initial investment=Present value of cash inflows

Present Value of Annuity Factor(P)=A{1-[(1+r)^-n]/r}

Where,

A=Annuity Amount= A

r=ROI= 0.085

n=No. of periods= 9

Now putting values in formula,

= A{1-[(1+ 0.085)^-9 ]/ 0.085}

= A{1-[( 1.085)^-9 ]/ 0.085}

= A{1-[ 0.47988 ]/ 0.085}

= A{ 0.52012 / 0.085}

= A{ 6.11906}

Thus;

95,200= A{ 6.11906}

A=95200/6.11906

A=15557.938 or $15,558

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