Question

Compute the PI statistic for Project X with the cash flows shown below if the appropriate cost of capital is 10 percent.

Time    0 1 2 3 4

Cash Flow -$10,000 $3,500 $2,000 -$5,148 $6,000

A. 1.11

B. 0.42

C. 1.19

D. 1.25

Answer 1

Given about project X

current cost C0 = $10000

cost of capital r = 10%

expected future cash flow are as follow:

CF1 = $3500

CF2 = $2000

CF3 = -$5148

CF4 = $6000

So, PV of the future cash flow using compounding formula is

PV = CF1/(1+r) + CF2/(1+r)^2 + CF3/(1+r)^3 + CF4/(1+r)^4

=> PV = 3500/1.1 + 2000/1.1^2 - 5148/1.1^3 + 6000/1.1^4 = $5065.02

So, profitability index of the project is PV/C0 = 5065.02/10000 = 0.51

Given the data, profitability index of the project is 0.51

There is some problem with option available. Calculation and methods are explained properly above.