Question

A firm is considering investing in a 15-year capital budgeting
project with a net investment of $14 million. The project is
expected to generate annual net cash flows each year of $2 million
and a terminal value at the end of the project of $10 million. The
firm’s cost of capital is 9 percent and marginal tax rate is 40%.
What is the profitability index of this investment?

0.35

0.78

2.86

1.54

1.35

Answer #1

**The profitability index of project A is computed as
shown below:**

**= Present value of future cash flows / Initial
investment**

**Present value is computed as follows:**

**= Future value / (1 + r) ^{n}**

= $ 2 million / 1.09^{1} + $ 2 million /
1.09^{2} + $ 2 million / 1.09^{3} + $ 2 million /
1.09^{4} + $ 2 million / 1.09^{5} + $ 2 million /
1.09^{6} + $ 2 million / 1.09^{7} + $ 2 million /
1.09^{8} + $ 2 million / 1.09^{9} + $ 2 million /
1.09^{10} + $ 2 million / 1.09^{11} + $ 2 million /
1.09^{12} + $ 2 million / 1.09^{13} + $ 2 million /
1.09^{14} + $ 2 million / 1.09^{15} + $ 10 million
/ 1.09^{15}

**= $ 18.86675727 million**

**So, the profitability index is computed as
follows:**

= $ 18.86675727 million / $ 14 million

**= 1.35 Approximately**

Feel free to ask in case of any query relating to this question

A capital investment project has total installed cost of $25
million and a terminal value of $16 million at the end of its
10-year life. The project is expected to generate $5 million in net
cash flows after tax each year. The firm’s marginal tax rate is 40
percent, and its cost of capital is 7 percent. Calculate the
profitability index of this project.

You are evaluating a capital budgeting replacement project with
a net investment of $85,000, which includes both an after-tax
salvage from the old asset of $5,000 and an additional working
capital investment of $10,000. The expected annual incremental cash
flows after-tax is $14,000. The project has a life of 9 years with
an expected terminal value at the end of the project of $13,000.
The cost of capital of the firm is 10 percent and the firm’s
marginal tax rate...

A firm is considering a replacement project which requires the
initial outlay of $300,000 which includes both an after-tax salvage
from the old asset of $12,000 and an additional working capital
investment of $8,000. The 12-year project is expected to generate
annual incremental cash flows of $54,000 and have an expected
terminal value at the end of the project of $20,000. The cost of
capital is 15 percent, and its marginal tax rate is 40 percent.
Calculate the net present...

A firm is considering two capital investment projects. Project A
involves an initial cost of $15,000. The discounted present value
of all future cash flows is $18,000. Project B requires an initial
expenditure of $25,000. The discounted present value of all future
cash flows is $29,000.
(i)
Calculate the net present value of each of the two projects.
Which would be preferred according to the net present value
criterion?
(ii)
Calculate the profitability index of each of the two projects....

16 A firm is considering a replacement project which requires
the initial outlay of $300,000 w-hich includes both an after-tax
salvage from the old asset of $12,000 and an additional working
capital investment of $8,000. The 12-year project is expected to
generate annual incremental cash flows of $54,000 and have an
expected terminal value at the end of the project of $20,000. The
cost of capital is 15 percent, and its marginal tax rate is 40
percent. Calculate the net...

A firm is considering three different projects for investment.
Project A will require an initial investment of $100,000 today and
will generate annual cash flows of $25,000 for a five-year period.
Project B will require an initial investment of $150,000 today will
generate annual cash flows of $35,000 for a five-year period.
Project C will require an initial investment of $275,000 today, and
will generate a cash flow of $75,000 in the first year. Cash flows
will grow by 3%...

The Aubergine Corporation is considering investing in a project
that requires an initial outlay of $400,000 and has a profitability
index of 1.5. It is expected to generate equal annual cash flows
over the next 12 years. The required return for this project is
20%. The NPV of this project is:

A firm is considering three different projects for
investment. Project A will require an initial investment
of $100,000 today and will generate annual cash flows of $25,000
for a five-year period. Project B will require an
initial investment of $150,000 today will generate annual cash
flows of $35,000 for a five-year period. Project C will
require an initial investment of $275,000 today, and will generate
a cash flow of $75,000 in the first year. Cash flows
will grow by 3% per year for project...

Shanks Corporation is considering a capital budgeting project
that involves investing $600,000 in equipment that would have a
useful life of 3 years and zero salvage value. The company would
also need to invest $20,000 immediately in working capital which
would be released for use elsewhere at the end of the project in 3
years. The net annual operating cash inflow, which is the
difference between the incremental sales revenue and incremental
cash operating expenses, would be $300,000 per year....

You are evaluating a capital budgeting project that costs
$25,000 and is expected to generate cash flows equal to $10,000 per
year for four years. The required rate of return is 10 percent.
Compute the project’s (a) net present value, (b) profitability
index, and (c) internal rate of return. (d) Should the project be
purchased?

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 6 minutes ago

asked 7 minutes ago

asked 13 minutes ago

asked 17 minutes ago

asked 18 minutes ago

asked 33 minutes ago

asked 37 minutes ago

asked 37 minutes ago

asked 39 minutes ago

asked 40 minutes ago

asked 42 minutes ago

asked 42 minutes ago