In: Finance
Use the following information for the next two questions. You are creating a cash flow project for your new venture, CBD IPA, a cannabis-infused beer and have made the following assumptions for the business:
1.
Sales revenue in year 3 = Number of canes sales x price per can
= 10,000 x (1.1)2 x $ 4 x (1.02)2
= 10,000 x 1.21 + $ 4 x 1.0404
= 12,100 x $ 4.1616
= $ 50,355.36
2.
Sales revenue in year 4 = Number of canes sales x price per can
= 10,000 x (1.1)3 x $ 4 x (1.02)3
= 10,000 x 1.331 + $ 4 x 1.061208
= 13,310 x $ 4.244832
= $ 56,498.71392
Operating expenses in year 4 = First year sales revenue x (1+0.1)3
= $ 10,000 x $ 4 X (1.1)3
= $ 10,000 x $ 4 X 1.331
= $ 53,240
Operating income in year 4 = Sales revenue – Operating expenses
= $ 56,498.71392 - $ 53,240 = $ 3,258.71392 or $ 3,258.71
Profitability index refers to the ratio between discounted benefit to the discounted cost of a project.
It is a useful financial tool to decide the acceptability of investment by measuring the present value of benefit of the project obtained from every dollar invested.
Profitability index greater than one indicates that present value of cash inflows is higher than investment and the project earns a profit and hence acceptable.
Profitability index equal to one reveals the breakeven state of the project. Project is in a no profit and no loss state and all the expenses are covered without generating any profit.
Profitability index less than one points out that present value of cash inflows is less than the amount invested and the project incurring a loss and hence not acceptable.