Question

1. A four-year financial project has estimates of net cash flows shown in the following table:

Year	Net Cash Flow
1	$20,000
2	25,000
3	30,000
4	35,000

It will cost $65,000 to implement the project, all of which must be invested at the beginning of the project. After the fourth year, the project will have no residual value.

Using the most likely estimates of cash flows, conduct a discounted cash flow calculation assuming a 20 percent hurdle rate with no inflation.

What is the discounted profitability index of the project?

Answer 1

The given figures are:

Initial Cash Outflow= $65,000

Hurdle rate = 20%

Calculation of discounted cash inflow:

Year Net cash flow Discount factor Discounted cash flows ($)

(In $) (@ 20%) (Net cash flows* Discount factor)

1 20,000 0.833 16,660   

2 25,000 0.694 17,350

3 30,000   0.579 17,370

4 35,000 0.482 16,870

  Total discounted cash flows 68,250

Discounted profitability index= PV of future cash inflow/ Initial investment

Hence, the profitability index is $68,250/ $65,000= 1.05