Question

The SAI Inc. is planning to set up a new store. The startup cost of the...

The SAI Inc. is planning to set up a new store. The startup cost of the store is $650,000. The store will increase revenue by $270,000 each year for the next six years and all costs including costs of merchandise, labor, utilities, and taxes are $130,000 per year. The store will require upgrade to the store front every two years at a cost of $35,000 each time. At the end of the six years, the store inventory will be sold off at a super sale to receive $10,000 after taxes and the company will cease operations. The company’s cost of capital is 4.5 percent. The level of risk of the product sales is the same as the overall risk for the company.

What is the profitability index of the new store decision?

A.

1.0283
B.

1.9845
C.

1.2471
D.

1.5456
E.

1.1542
F.

1.3571
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Homework Answers

Answer #1

Intial Investment = $650,000

Profitability Index = PV of Cash Flows / Intial Investment

Present Value of Cash Flows is calculated by the following table :

Item Years Amount Discounting Rate PV of Cash Flow
Annual Cash Profit 140000 5.1579 722102.15
Upgrade Cost at end of Y2 2 35000 0.9157 -32050.55
Upgrade Cost at end of Y4 4 35000 0.8386 -29349.65
Residual Value 6 10000 0.7679 7678.96
Total 668380.91

Profitability Index = 668380.91/650000 = 1.0283

Hence, the answer is Option A.

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