Question

What is the Profitability Index of a project that costs $22,000 today and is expected to generate annual cash inflows of $5,000 for the following 7 years. Cost of capital is 9%. Round to two decimal places.

Answer 1

The profitability index is computed as shown below:

= Present value of future cash flows / Initial investment

Present value of future cash flows is computed as follows:

= $ 5,000 / 1.09¹ + $ 5,000 / 1.09² + $ 5,000 / 1.09³ + $ 5,000 / 1.09⁴ + $ 5,000 / 1.09⁵ + $ 5,000 / 1.09⁶ + $ 5,000 / 1.09⁷

= $ 25,164.76418

So, the profitability index is computed as follows:

= $ 25,164.76418 / $ 22,000

= 1.14 Approximately

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