Question

Kathy has been presented with an investment opportunity which will yield end-of-year cash flows of $34,000 per year in Years 1 through 4, $40,000 per year in Years 5 through 9, and $48,000 in Year 10. This investment will cost the firm $260,000 today, and the firm's cost of capital is 5%. What is the profitability index for this investment?

Select one:

a. 1.48

b. 1.13

c. 1.36

d. 1.05

e. 0.91

f. 0.42

g. 0.48

Answer 1

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

=34000/1.05+34000/1.05^2+34000/1.05^3+34000/1.05^4+40000/1.05^5+40000/1.05^6+40000/1.05^7+40000/1.05^8+40000/1.05^9+48000/1.05^10

=34000[1/1.05+1/1.05^2+1/1.05^3+1/1.05^4]+40000[1/1.05^5+1/1.05^6+1/1.05^7+1/1.05^8+1/1.05^9]+48000/1.05^10

=(34000*3.545950504)+(40000*3.561871171)+(48000*0.613913253)

=$292505.00(Approx)

PI=Present value of inflows/Present value of outflows

=$292505/$260000

=1.13(Approx).