Question

10. Starwood Hotel & Resort World has a project with initial investment requiring $-170,000 and the following cash flows will be generated because of the project: $42,500; $41,000; $52,000; and $67,000 respectively at the end of each year for the next four years. If the required rate of return is 0.14, find the Profitability Index (PI) of the project.

Group of answer choices

1.26

0.84

0.62

1.59

none of the answers is correct

Answer 1

Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$170,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the required rate of return of 14%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 14% required rate of return is -$26,403.23.

Profitability Index= -$26,403.23 + $170,000/ $170,000

= $143,596.77/ $170,000

= 0.8447 0.84.

Hence, the answer is option b.

In case of any query, kindly comment on the solution.