In: Finance
The following are the cash flows of two projects: Year Project A Project B 0 ?$ 220 ?$ 220 1 100 120 2 100 120 3 100 120 4 100 If the opportunity cost of capital is 10%, what is the profitability index for each project? (Do not round intermediate calculations. Round your answers to 4 decimal places.)
Profitability Index (PI) for PROJECT-A
Year |
Annual cash inflow ($) |
Present Value factor at 10% |
Present Value of Annual cash inflow ($) |
1 |
100 |
0.90909 |
90.91 |
2 |
100 |
0.82645 |
82.64 |
3 |
100 |
0.75131 |
75.13 |
4 |
100 |
0.68301 |
68.30 |
TOTAL |
316.99 |
||
Profitability Index (PI) for the Project-A = Present Value of annual cash inflows / Initial Investment
= $316.99 / $220
= 1.44
Profitability Index (PI) for PROJECT-B
Year |
Annual cash inflow ($) |
Present Value factor at 10% |
Present Value of Annual cash inflow ($) |
1 |
120 |
0.90909 |
109.09 |
2 |
120 |
0.82645 |
99.17 |
3 |
120 |
0.75131 |
90.16 |
TOTAL |
298.42 |
||
Profitability Index (PI) for the Project-B = Present Value of annual cash inflows / Initial Investment
= $298.42 / $220
= 1.36
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.