Question

Hendrix Guitars is considering the following project. The Project cash flows are below: Initial Cost is $ 2.1 million; annual net cash flows are $750,000 per year for 5 years. what is the Profitablity Index If the appropriate discount rate is 7.5%?

Answer 1

Given,

Initial cost = $2.1 million or $2100000

Annual cash flows (A) = $750000

No. of years (n) = 5 years

Discount rate (r) = 7.5% or 0.075

Solution :-

Present value of cash flows = A/r x [1 - (1 + r)^-n]

= $750000/0.075 x [1 - (1 + 0.075)^-5]

= $10000000 x [1 - (1.075)^-5]

= $10000000 x [1 - 0.696558632]

= $10000000 x 0.303441368 = $3034413.68

Now,

Profitability index = Present value of cash flows Initial cost

= $3034413.68 $2100000 = 1.44