Question

Year Cash Flow

0 ?$9,700

1 3,700

2 2,400

3 4,200

Required :

(a) What is the profitability index for the cashflows if the relevant discount rate is 7 percent?

(b) What is the profitability index for the cashflows if the relevant discount rate is 17 percent?

(c) What is the profitability index for the cashflows if the relevant discount rate is 25 percent?

Answer 1

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

At 7%:

Present value of inflows=3700/1.07+2400/1.07^2+4200/1.07^3

=$8982.65

PI=Present value of inflows/Present value of outflows

=$8982.65/$9700

=0.926(Approx).

At 17%:

Present value of inflows=3700/1.17+2400/1.17^2+4200/1.17^3

=$7537.98

PI=Present value of inflows/Present value of outflows

=$7537.98/$9700

=0.777(Approx).

At 25%:

Present value of inflows=3700/1.25+2400/1.25^2+4200/1.25^3

=$6646.4

PI=Present value of inflows/Present value of outflows

=$6646.4/$9700

=0.685(Approx).