Question

Bill plans to open a self-serve grooming center in a storefront. The grooming equipment will cost $430,000, to be paid immediately. Bill expects aftertax cash inflows of $93,000 annually for seven years, after which he plans to scrap the equipment and retire to the beaches of Nevis. The first cash inflow occurs at the end of the first year. Assume the required return is 13 percent.

  

What is the project’s profitability index (PI)? (Do not round intermediate calculations. Round your answer to 3 decimal places, e.g., 32.161.)

Answer 1

The project's profitability index is computed as shown below:

= Present value of future cash flows / Initial Investment

The present value of future cash flows is computed as follows:

= $ 93,000 / 1.13¹ + $ 93,000 / 1.13² + $ 93,000 / 1.13³ + $ 93,000 / 1.13⁴ + $ 93,000 / 1.13⁵ + $ 93,000 / 1.13⁶ + $ 93,000 / 1.13⁷

= $ 411,302.7702

So, the profitability index will be:

= $ 411,302.7702 / $ 430,000

= 0.957 Approximately

Feel free to ask in case of any query relating to this question