Question

Caspian Sea Drinks is considering buying the J-Mix 2000. It will allow them to make and sell more product. The machine cost $1.93 million and create incremental cash flows of $590,625.00 each year for the next five years. The cost of capital is 10.39%. 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

= $ 590,625 / 1.1039¹ + $ 590,625 / 1.1039² + $ 590,625 / 1.1039³ + $ 590,625 / 1.1039⁴ + $ 590,625 / 1.1039⁵

= $ 2,216,803.802

So, the profitability index is computed as follows:

= $ 2,216,803.802 / $ 1,930,000

= 1.1486 Approximately

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