Question

The following are the cash flows of two projects: Year Project A Project B 0 −$ 290 −$ 290 1 170 190 2 170 190 3 170 190 4 170 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.)

Answer 1

profitaliblity index = Present value of cash inflows / present value of cash outflows

since at year 0 the cash out flows for both the projects are = -$290.

the present value of cash outflows for project A = -$290.

the present value of cash outflows for project B = -$290.

the following table shows the calculation of present value of cash inflows:

year	present value factor @11%=>(1 / (1+r)^n) [r= 0.11 n = 1,2,3,4]	Cash inflow project A	Present value of project A cash inflow [present value factor * cash inflow]	cash inflow project B	present value of project B cash inflow [present value factor * cash inflow]
1	1 /1.11 =>0.9009009	170	153.153153153	190	171.171171171
2	1/ (1.11)^2=>0.88162243324	170	137.97581365	190	154.208262315
3	1/(1.11)^3=>0.73119138129	170	124.302534819	190	138.926362445
4	1/(1.11)^4=>0.65873097413	170	111.984265602	nil	nil
		present value of cash inflow project A	527.415767225	present value of cash inflow project B	464.305795931

now,

profitability index of project A = $527.415767225 / 290 =>1.8187.

profitability index of project B = $464.305795931 / 290 =>1.6011.