Question

The profitability index (PI) of a project is 1.1, and the initial investment (cost) is $10,000

. What do you know about the project's net present value (NPV) and its internal rate of return (IRR)?

Answer 1

Profitability Index = Present Value of Cash Flows / Initial Investment

1.1 =Present Value of Cash Flows / 10,000

Present Value of Cash Flows= 10,000 * 1.1

Present Value of Cash Flows = $11,000

Now, We know that

Net Present Value = Present Value of Cash flows - Initial Investment

= 11,000 - 10,000

Net present value = $1000

Internal rate of return : The Irr is the average return of the project gives through all the years of operations.

Initial Investment = Present value of cash flows / (1 + Internal rate of return)

10,000 = 11,000 / (1 + IRR)

(1 + IRR) = 11,000 / 10,000

(1 + IRR) = 1.1

IRR = 1.1 - 1

IRR = 0.10 or 10%