In: Finance
The following are the cash flows of two projects:
Year | Project A | Project B | ||||
0 | ?$ | 380 | ?$ | 380 | ||
1 | 210 | 280 | ||||
2 | 210 | 280 | ||||
3 | 210 | 280 | ||||
4 | 210 | |||||
If the opportunity cost of capital is 11%, what is the profitability index for each project? (Do not round intermediate calculations. Round your answers to 4 decimal places.)
Profitability Index (PI) for the Project-A
Year |
Annual cash inflow ($) |
Present Value factor at 11% |
Present Value of Annual cash inflow ($) |
1 |
210 |
0.900901 |
189.19 |
2 |
210 |
0.811622 |
170.44 |
3 |
210 |
0.731191 |
153.55 |
4 |
210 |
0.658731 |
138.33 |
TOTAL |
651.51 |
||
Profitability Index (PI) for the Project = Present Value of annual cash inflows / Initial Investment
= $651.51 / $380
= 1.7145
Profitability Index (PI) for the Project-B
Year |
Annual cash inflow ($) |
Present Value factor at 11% |
Present Value of Annual cash inflow ($) |
1 |
280 |
0.900901 |
252.25 |
2 |
280 |
0.811622 |
227.25 |
3 |
280 |
0.731191 |
204.74 |
TOTAL |
684.24 |
||
Profitability Index (PI) for the Project = Present Value of annual cash inflows / Initial Investment
= $684.24 / $380
= 1.8006
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.