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?
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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