Question

Initial investment $15,000. Cash inflow for the next 3 years: $6,800, $7,200, and $7,500. What is the project’s profitability index? Should you invest in this project and why?

Answer 1

There is no Discount rate given in the question. Hence, cash inflows given are taken as discounted cash flows. In case a discount rate needs to be taken into consideration please drop a comment

Profitability Index = 1.43

Since the project has profitability index of more than 1 this shows that the value of cash inflows exceed the value of cash outflows and hence the project should be accepted.

Profitability Index (using discounted cash flows) = 1.17

Since the project has profitability index of more than 1 this shows that the value of discounted cash inflows exceed the value of cash outflows and hence the project should be accepted.

Workings & Rationale

Profitability Index = Present Value of Future Cash Flows/Initial Investments

Profitability Index = (6800+7200+7500)/15000 = 21500/15000 = 1.43

In case discount rate is available, PV of cash flows will be calculated in the following manner

Profitability Index = 17609.25/15000 = 1.17

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