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Based on the profitability index rule, should a project with the following cash flows be accepted...

Based on the profitability index rule, should a project with the following cash flows be accepted if the discount rate is 15 percent? Why or why not? (i.e. Calculate the profitability index (PI) and explain why the project should or should not be accepted.)

Year: 0,1,2,3

Cash Flow: -32100, 11,800, 0, 22,600

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Answer #1

Profitability index = Present value / Initial investment

Present value = 11,800 / (1 + 0.15)1 + 22,600 / (1 + 0.15)3

Present value = 10,260.87 + 14,859.87

Present value = 25,120.74

Profitability index = 25,120.74 / 32,100

Profitability index = 0.78

Project should NOT be accepted as it has a profitability index of less than 1. A profitability index of less than 1.0 indicate the deficit of the outflows is greater than the discounted inflows, and the project should not be accepted.

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