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ABC Inc. is considering an investment of $1,583 million with after-tax cash inflows of $318 million...

ABC Inc. is considering an investment of $1,583 million with after-tax cash inflows of $318 million per year for six years and an additional after-tax salvage value of 77 million in Year 6. The required rate of return is 18%. What is the investment’s Profitability Index (PI)?

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Answer #1

Profitability Index = PV of inflows/Cash outflow

Cash outflow = $1,583 millions

$318 million per years for 6 years is a series of the annuity payment, so we can find its PV by PV of annuity formula and the additional cash inflow of $77 million in the sixth year, discount it back for 6 years at the rate of return.

Rate of return (r) = 18%

Periodic payment (P) =$318 million

Number of periods (n) = 6 years

Additional Cash inflow (C) = $77 million

Therefore,

PV of Inflow = $1140.7608 million (approximately)

Profitability Index = 1140.7608/1583 = 0.72

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