Question

What is the profitability index for Project A with a cost of capital of 8%?

Year Project A Project B

0 ($42,000.00) ($45,000.00)

1 $14,000.00 $28,000.00

2 $14,000.00 $12,000.00

3 $14,000.00 $10,000.00

4 $14,000.00 $10,000.00

5 $14,000.00 $10,000.00

Answer 1

It should be taken into account that only the profitability index of project A is being asked-

Profitability index of project a could be calculated using the net cash inflows at the present and comparing it with net cash outflows at the present.

Value of cash inflows at the present

=( (14000/1.08)+(14000/ (1.08)^2+(14000/(1.08)^3+(14000/(1.08)^4+(14000/(1.08)^5)

= (12962.96+ 12002.74+11113.65+10290.41+9528.16)

= 55898 (Approx)

Net value of cash outflow at the beginning =42000

Profitability index=[present value of future inflows / initial outflows]

=[55898/42000]

=1.33

Profitability index is 1.33 for project A