Question

Calculate the profitability index for the below projects and indicate your order of choices.

Project

Present Value

Investment

A

$175,000

$125,000

B

$160,000

$110,000

C

$180,000

$130,000

Select one:
a. B, C and A
b. C, A and B
c. B, A and C
d. A, C and B

Answer 1

Profitability index = Present value of. cashflows/initial investment

Calculation of profitability index of project A:

Given present value of cashflows= $175,000

Initial investment = $125,000

Profitability index = $175,000/$125,000

. = 1.4

Calculation of profitability index of project B:

Given present value of cashflows = $160,000

Initial investment = $110,000

Profitability index = 1.45

Calculation of profitability index of project B:

Given present value of cashflows= $180,000

Intial investment = $130,000

Profitability index = $180,000/$130,000

. = 1.38

These projects profitability index is more than one, so we should choose the projects in the way that it should yield more value to the company. Project with high profitability index gives more value to the company so order of the projects is B (PI 1.45), A(1.40), C (1.38)

So option 'C' is correct.