Question

Find the profitability index (PI) for the following series of future cash flows, assuming the company’s cost of capital is 14.20 percent. The initial outlay is $495,936.

Year 1: $148,027

Year 2: $167,396

Year 3: $164,126

Year 4: $172,109

Year 5: $149,333

Round the answer to two decimal places.

Answer 1

Profitability index is a ratio of present value of future cash flow and the initial investment.

It is calculated using the below formula:

Profitability Index= PV of future cash flows/Initial investment

PV of future cash flows is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0=0.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the third cash flow cash flow, press the NPV button and enter the interest rate.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is $50,311.70

Profitability Index= $50,311.70/$495,936= 0.10.