Question

Suppose you are given the following two projects A and B with the cash flows below, if the cost of capital is 10%, what is the Profitability Index (PI) of projects A and B?

Year	Project A	Project B
0	-5000	-6000
1	1500	1500
2	2000	2500
3	3000	4000
4	3500	4000

Answer 1

Profitability Index (PI) for Project-A

Year	Annual cash flows ($)	Present Value factor at 10%	Present Value of Annual cash flows ($)
1	1,500	0.909091	1,363.64
2	2,000	0.826446	1,652.89
3	3,000	0.751315	2,253.94
4	3,500	0.683013	2,390.55
TOTAL			7,661.02

Profitability Index = Present Value of annual cash inflows / Initial Investment

= $7,661.02 / $5,000

= 1.53

Profitability Index (PI) for Project-B

Year	Annual cash flows ($)	Present Value factor at 10%	Present Value of Annual cash flows ($)
1	1,500	0.909091	1,363.64
2	2,500	0.826446	2,066.12
3	4,000	0.751315	3,005.26
4	4,000	0.683013	2,732.05
TOTAL			9,167.07

Profitability Index = Present Value of annual cash inflows / Initial Investment

= $9,167.07 / $6,000

= 1.53

NOTE

The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)ⁿ], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.