Question

What is the profitability index for an investment with the following cash flows given a 8 percent required return?
      

Year	Cash Flow
0	$-20,500
1	$7,100
2	$9,700
3	$8,500

1.06

1.07

1.04

1.00

1.01

Answer 1

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= -$20,500. 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 required return 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 $1,137.83.

Profitability Index= $1,137.83 + $20,500/ $20,500

                                   = $21,637.83/ $20,500

                                   = 1.0555 1.06

Hence, the answer is option a.

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