Question

A project has cash flows of −$144,000, $60,800, $62,300 and $75,000 for Years 0 to 3, respectively. The required rate of return is 13 percent. What is the profitability index? Should you accept or reject the project based on this index value?

Answer 1

The profitability index is computed as shown below:

= Present value of future cash flows / Initial investment

Present value is computed as follows:

= Future value / (1 + r)ⁿ

= $ 60,800 / 1.13 + $ 62,300 / 1.13² + $ 75,000 / 1.13³

= $ 154,574.1103

So, the profitability index will be as follows:

= $ 154,574.1103 / $ 144,000

= 1.0734 Approximately

We shall accept the project since the profitability index is greater than 1, which implies that the NPV of the project is positive.

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