A firm is considering a project that requires an initial investment of $250,000. The life of...

A firm is considering a project that requires an initial investment of $250,000. The life of this project is five years. Cash flows for each year are estimated as follows:

Year 1	Year 2	Year 3	Year 4	Year 5
$80,000	$120,000	$160,000	$40,000	-$90,000

The cost of capital of this project is 8%. Calculate the profitability index and make a decision.

Solutions

Expert Solution

Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

Net present value is calculated using a financial calculator by inputting the below:

Press the CF button.
CF0= -$250,000. It is entered with a negative sign since it is a cash outflow.
Cash flow for each year should be entered.
Press Enter and down arrow after inputting each cash flow.
After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 8%.
Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value of cash flows is $22,116.60.

Profitability Index= $22,116.60 + $250,000/ $250,000

= $272,116.60/ $250,000

= 1.0885.

The project should be accepted since the project has a profitability index greater than 1.

In case of any query, kindly comment on the solution.

jeff jeffy answered 1 week ago

Next > < Previous

Related Solutions

A firm is considering a project that requires an initial investment of $420,000. The life of...

A firm is considering a project that requires an initial investment of $420,000. The life of this project is five years. Cash flows for each year are estimated as follows: Year 1 Year 2 Year 3 Year 4 Year 5 $180,000 $220,000 $160,000 -$20,000 -$80,000 If the cost of capital of this project is 8%, what is the payback period of this project?

A firm is considering a project that requires an initial investment of $180,000. The life of...

A firm is considering a project that requires an initial investment of $180,000. The life of this project is five years. Cash flows for each year are estimated as follows: Year 1 Year 2 Year 3 Year 4 Year 5 $105,000 $190,000 $50,000 -$60,000 -$110,000 The cost of capital of this project is 8%. Calculate the internal rate of return of the project and make a decision. Accept since the IRR is 5.04%, which is less than the required rate....

A firm is considering a project that requires an initial investment of $55,000. The project is...

A firm is considering a project that requires an initial investment of $55,000. The project is expected to generate revenues of $80,000 per year for three years. Operating expenses will be 65% of revenues. The equipment will be depreciated on a straight-line basis to a zero net salvage value. The equipment will have a life of 3 years. The project feasibility study, which was just completed, cost $35,000. The project requires an initial investment in working capital of $5,000. Further...

A firm is planning an investment in a project. The initial investment is 250,000. The project...

A firm is planning an investment in a project. The initial investment is 250,000. The project returns $100,000 cash at the end of one year. At the end of second year the project returns cash of amount $F. These are only cash flows from the project. If the IRR for the project is 10%, what is the amount $F?

Turnbull Co. is considering a project that requires an initial investment of $270,000. The firm will...

Turnbull Co. is considering a project that requires an initial investment of $270,000. The firm will raise the $270,000 in capital by issuing $100,000 of debt at a before-tax cost of 8.7%, $30,000 of preferred stock at a cost of 9.9%, and $140,000 of equity at a cost of 13.2%. The firm faces a tax rate of 40%. What will be the WACC for this project? 9.88% 11.36% 10.87% 6.42% Consider the case of Kuhn Co. Kuhn Co. is considering...

A firm is considering a project that requires an initial investment of $300,000 in new equipment,...

A firm is considering a project that requires an initial investment of $300,000 in new equipment, which has a five-year life and a CCA rate of 30 percent. An initial investment in raw materials inventory of $50,000 is also required to support the project, which will rise to 15 percent of sales. The project will generate sales revenue of $400,000 in the first year, which will grow at 4 percent per year. Variable costs will be $220,000 for the first...

considering a project that requires an initial investment of $270,000. The firm will raise the $270,000...

considering a project that requires an initial investment of $270,000. The firm will raise the $270,000 in capital by issuing $100,000 of debt at a before-tax cost of 9.6%, $30,000 of preferred stock at a cost of 10.7%, and $140,000 of equity at a cost of 13.5%. The firm faces a tax rate of 25%, what will be the WACC for this project?\ a. 11.97% b. 13.73% c. 9.04% d. 10.86%

A project requires an initial investment of $20,000,000. The life of the project is 3 years....

A project requires an initial investment of $20,000,000. The life of the project is 3 years. The $20,000,000 investment will be depreciated using the three-year modified accelerated cost recovery system (MACRS) class (see the table below). The firm estimates that, in the first year, the revenues and total production costs will be $60,000,000 and $45,000,000, respectively, in nominal terms. After that the sales and production costs are expected to increase at the inflation rate of 4 percent per year over...

18 A firm is considering an investment project which requires the initial outlay of $10 million....

18 A firm is considering an investment project which requires the initial outlay of $10 million. The 12-year project is expected to generate annual net cash flows each year of $1 million and have the expected terminal value at the end of the project of $5 million. The cost of capital is 6 percent, and its marginal tax rate is 40 percent. Calculate the profitability index of this project. 0.84 0.09 1.70 1.34 1.09

• A project to replace Dr. Robert Doback’s boat requires an initial investment of $250,000 and...

• A project to replace Dr. Robert Doback’s boat requires an initial investment of $250,000 and is expected to produce operating earnings (before depreciation and tax (EBITDA)) of $60,000 per year for 5 years • Prestige Worldwide pays corporate taxes at a rate of 22% and can depreciate the initial investment for tax purposes at 25% in each of the first four years • Their public debt trades at 4% and they estimate their cost of equity at 14%, the...

Subjects