Question

Suppose your firm is considering investing in a project with the accompanying cash flows, that the required rate of return on projects of this risk class is 11 percent, and that the maximum allowable payback and discounted payback statistics for your company are 4 and 4.5 years, respectively. Time Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Cash Flow -$125,000 -$75,650 $75,000 $49,000 $115,000 $81,850 What is the Profitability Index? Would you accept or reject the project? Why?

Answer 1

As is observable the Payback and Discounted Payback Periods are 3.67 and 4.43 respectively, thereby coming in below the cut-off limit of 4 and 4.5 years. Further, the profitability index is 1.22 and the project NPV is positive at $ 27874.96. Therefore, the project should be accepted.