Question

Year Cash Flow

0 −$9,100

1 5,300

2 5,700

3 4,900

a. What is the profitability index for the cash flows if the relevant discount rate is 8 percent?

b. What is the profitability index for the cash flows if the relevant discount rate is 19 percent?

c. What is the profitability index for the cash flows if the relevant discount rate is 23 percent?

Please be very specific in where you found each number

Answer 1

The profitability index is defined as the PV of the future cash flows divided by the initial investment.

a. The equation for the profitability index at a required return of 8 percent is:

PI = [$5,300/1.08 + $5,700/1.08² + $4,900/1.08³] / $9,100 = 1.504

b. The equation for the profitability index at a required return of 19 percent is:

PI = [$5,300/1.19 + $5,700/1.19² + $4,900/1.19³] / $9,100 = 1.251

c. The equation for the profitability index at a required return of 23 percent is:

PI = [$5,300/1.23 + $5,700/1.23² + $4,900/1.23³] / $9,100 = 1.177