Question

a firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of $10,000 in year 1, $20,000 in year 2, and $10,000 in year 3. If the company's cost of capital is 8 percent, find the profitability index of the project and indicate if the project should be accepted or not.

a. .98, accept

b. 1.02, accept

c. -1.02, reject

d .98, reject

Answer 1

Present Value = Future value/ ((1+r)^t)
where r is the interest rate that is 8% and t is the time period in years.
Profitability index (PI) = sum of present values of future cash flows/initial investment
t	0	1	2	3
future cash flow		10000	20000	10000
present value		9259.26	17146.78	7938.32
sum of present values	34344.36
initial investment	35000
Profitability index	34344.36/35000
Profitability index	0.981
Since the PI is less than 1 you should reject the project.
d) .98, reject