Question

Find the profitability index (PI) for the following series of future cash flows, assuming the company's cost of capital is 10.95 percent. The initial outlay is $468,783.

Year 1: 137,140

Year 2: 160,686

Year 3: 141,697

Year 4: 187,086

Year 5: 124,349

Round the answer to two decimal places.

Answer 1

Profitability index is a ratio of the discounted cash flow to the initial cash flow of the project. It is calculated using the below formula:

Profitability Index= PV of future cash flows/Initial investment

Net present value is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$468,783.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the fifth cash flow cash flow, press the NPV button and enter the interest rate of 10.95%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is $86,527.08.

Profitability Index= $86,527.08/ $468,783 = 0.18