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A project with an initial cost of $57,200 is expected to provide annual cash flows of...

A project with an initial cost of $57,200 is expected to provide annual cash flows of $10,950 over the 9-year life of the project. If the required return is 9.2 percent, what is the project's profitability index?

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Answer #1

Profitability Index = (NPV + initial investment) / initial investment

NPV = PV of annual cash inflows - initial investment

PV of annual cash inflows is calculated using the formula for PV of an annuity. PV = P * (1 - (1 + r)-n) / r, where

P = annual cash flow

r = rate of interest per year

n = number of years

PV of annual cash inflows = $10,950 * (1 - (1 + 0.092)-9) / 0.092 = $65,118

NPV = $65,118 - $57,200 = $7,918

Profitability Index = ($7,918 + $57,200) / $57,200 = 1.14

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