Question

Caspian Sea Drinks is considering buying the J-Mix 2000. It will allow them to make and sell more product. The machine cost $1.89 million and create incremental cash flows of $612,672.00 each year for the next five years. The cost of capital is 10.19%. What is the profitability index for the J-Mix 2000?

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

= $ 612,672 / 1.1019¹ + $ 612,672 / 1.1019² + $ 612,672 / 1.1019³ + $ 612,672 / 1.1019⁴ + $ 612,672 / 1.1019⁵

= $ 2,311,279.587

So, the profitability index will be computed as follows:

= $ 2,311,279.587 / $ 1,890,000

= 1.22 Approximately

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